INTRODUCTION
In any contemporary operating organisation, progress that the company is making is recorded as basis for, among a host of other essential things, decision-making and as a benchmark for measuring the firm’s performance for the period under scrutiny. A financial situation analysis is one such yardstick that documents current and future financial situation in an attempt to determine a financial strategy to help achieve organisational goals. As formally defined by Riahi-Belkaoui in 1998, financial analysis ‘is an information processing system used to provide relevant information for decision making’ (p. 1). The main sources of information for such analyses are published financial statements of the concerned company. Various accounts from published financial statements are evaluated in relation to each other to form performance indicators, which are then compared to ‘established’ standards. These performance indicators are better known as ratios, and constitute the main tools of conventional financial analysis. For the last several years, businesses have seen the rapid growth of the number of firms offering financial situation analysis services. This serves as a proof that more and more organisations are realising the importance of the analysis of their financial situations in order to keep up with the demands of the business world nowadays.
This paper is an analysis of financial situation of easyJet plc, one of the leading low-cost civil aviation companies in existence, operating in a very tough and highly competitive industry. The main purpose of this paper is to examine the financial statements of the company for the last twelve months by using tools such as Ratio Analysis to see how much growth easyJet has been able to achieve and also to see what might be the other factors that can influence the company’s growth and its decision making and than to see the limitations of the financial analysis. These performance indicators are better known as ratios and constitute the main tools of conventional financial analysis. For the last several years, businesses have seen the rapid growth of the number of firms offering financial situation analysis services. This serves as a proof that more and more organisations are realising the importance the analysis of their financial situation in order to keep up with the demands of the business world.
ORGANISATIONAL BACKGROUND[1]
The Company was founded by Stelios Haji-loannou in 1995 who still is the major share holder of the business group, offering low cost scheduled flights mainly in the European Union territory. The company grew from there onwards, from only 2 leased aeroplanes to 75 aircraft presently and has operations in 38 airport destinations in Europe providing transportation services that includes both leisure and business customers. From the basic facts regarding the company, it can be surmised that easyJet is one of the successful low cost airlines in Europe. easyJet achieved its growth through number of different strategic and financial key decisions. In 1998 easyJet acquired 40% stake in TEA which was a Swiss-based Chartered airline and re-branded into easyJet Switzerland. In order to reduce its cost and increase its profitability easyJet took drastic measures. For instance, the extensive use of IT services since 1998 that provided online ticket booking facility significantly reduced paper work. For the record, easyJet is one of the largest on line retailers in continent Europe, where 90% of their seats are sold through their website to reduce distribution cost for travel and maximise utilisation of each aircraft to reduce unit cost. easyJet also decided not to provide free catering services on board, not only it reduces cost but also avoid problems associated with it. In order to increase the awareness about the company and its operations and more importantly recognition of the brand among general public, another vital decision was made in the shape of successful prime time television programme called Airline during 1999. Another strategic decision was the merger with Go 2002, a company previously owned by British Airways that helped EasyJet to launch new routes and expand its operations. easyJet flies to main destinations airports throughout Europe and gain efficiency through rapid turnaround times and progressive landing charges agreement with the airports.
FINANCIAL RATIOS[2]
Atril & Mclaney (2004) mentioned that by calculating a relatively small number of ratios, it is often possible to build up a reasonably good picture of the position and performance of a business. Ratios help to highlight the financial strengths and weaknesses of a business, but they can not, by themselves, explain why certain strengths or weaknesses exist, or why certain changes occurred. Just by details investigation will find the reasons. Ratios can be grouped into certain categories; each of them identifies a particular aspect of financial performance or, position. There are five broad categories which define as follows: (1) Profitability; (2) Liquidity; (3) Financial Leverage; and (4) Asset Management (Pike & Neale 1999).
PROFITABILITY RATIOS
The following ratios may be used to evaluate the profitability of the company:
Ø Return on ordinary shareholder funds;
Ø Return on capital employed;
Ø Return on assets;
Ø Net profit margin; and
Ø Gross profit margin
Each of them are calculated for easyJet as follows:
TURNOVER
| YEAR | TURNOVER (in £) | CHANGE |
| 2006 | 1,619,700 | 21 |
| 2005 | 1,341,400 | 46 |
| 2004 | 1,091,000 | 29 |
| 2003 | 931,844 | 68 |
| 2002 | 551,844 | - |
From the said figures, easyJet has achieved remarkable consistent growth in its overall sales turnover, with more than double in terms of percentage of change.
RETURN ON ORDINARY SHAREHOLDER FUNDS (ROSF)
The ROSF compares the amount of profit for the period available to the owners with the owner’s stake in the business. For a limited company the ratio is as follows:
Net profit after taxation + preference dividend
ROSF = x 100
Ordinary share capital + reserves
RETURN ON SHAREHOLDER FUNDS (ROSF) RATIO
| YEAR | % |
| 2006 | 10.1 |
| 2005 | 7.1 |
| 2004 | 5.3 |
| 2003 | 4.4 |
| 2002 | 9.4 |
From the above computation, it shows that the longer the company operates, the amount of profit percentage available to the shareholders increases as well in parallel. This is mainly due to the increase in the realisation of profits of the company, as it exercises a profit-sharing system.
RETURN ON CAPITAL EMPLOYED (ROCE)
The ROCE is a fundamental measure of business performance. This ratio expresses the relationship between the net profit generated by business and long-term capital investment in the business. The ratio is expressed as follows.
Net profit before interest and taxation
ROCE = x 100
Share capital +Reserves +Long-term loans
RETURN ON CAPITAL EMPLOYED (ROCE) RATIO
| YEARS | % |
| 2006 | 7.30 |
| 2005 | 5.60 |
| 2004 | 6.16 |
| 2003 | 5.94 |
| 2002 | 8.89 |
It is evident that as time passes, the return on capital employed by the business fluctuates and cannot be pinpointed to one pattern. This is largely due to the differences in the focus on capital investment as business activities progresses. At one point in time, the firm may be very active in business investment and other periods, it may be not very keen on investing.
RETURN ON ASSETS (ROA)
The ROA ratio measures the efficiency of the company to use its assets to generate profit. The figure shows what the company is earning against every pound invested in assets. easyJet’s performance is steady as compared to industry standards. The formula for computing the ROA is as follows:
Net income
ROA = x 100
Total Assets
RETURN ON ASSETS (ROA)
| YEAR | % |
| 2006 | 4.43 |
| 2005 | 4.22 |
| 2004 | 4.69 |
| 2003 | 4.57 |
| 2002 | 6.72 |
From the previous results, it shows that easyJet has managed to use their assets effectively to generate profits. It has been markedly decreasing in the last few years though, but so are the rest of the companies in the aviation industry, mainly due to the reverberations of the September 11 attacks in 2001.
NET PROFIT MARGIN (NPM)
The net profit margin ratio relates the net profit for the period to the sales during that period. The ratio is expressed as follows:
Net profit before interest and taxation
NPM =
Sales
PROFIT MARGIN/NET PROFIT MARGIN RATIO
| YEARS | % |
| 2006 | 12.63 |
| 2005 | 5.06 |
| 2004 | 5.70 |
| 2003 | 5.53 |
| 2002 | 12.97 |
The ratio of the net profit to the amount of sales is witnessed to decrease over time, as larger costs are experienced by the company, especially for easyJet who belongs to the aviation industry, where overhead costs are said to go skyrocket high, mainly resulted from increase in oil prices worldwide, oil that is used in the flying of an aircraft but has witnessed improvement during 2006.
GROSS PROFIT MARGIN (GPM)
The gross profit margin ratio relates the gross profit of business to the sales generated for the same period. This represents the difference between sales and the cost of sales. Therefore it is the measure of profitability in buying (or producing) and selling goods or services before any other expense are taking into account. The gross profit margin is calculated as a follows:
Gross profit
GPM =
Sales
GROSS PROFIT MARGIN RATIO
| YEARS | % |
| 2006 | 13.75 |
| 2005 | 13.05 |
| 2004 | 14.82 |
| 2003 | 16.83 |
| 2002 | 25.12 |
The gross profit margin ratio of easyJet shows that the price of purchasing aircraft and other direct machines and equipment used to deliver service to passengers increase their purchase value as time progresses.
LIQUIDITY RATIOS
Liquidity ratios show how quickly the company can meet its short-term obligations using its current assets. The following ratios are needed to determine the status of liquidity of the firm under analysis:
Ø Current Ratio; and
Ø Quick Ratio
Each of them are calculated for easyJet as follows:
CURRENT RATIO (CR %)
The current ratio shows the ability of the company to pay its liabilities, i.e. debts and payables during the period. It is expressed as:
Current Assets
CURRENT RATIO =
Current Liabilities
CURRENT RATIO
| Years | % |
| 2006 | 4.17 |
| 2005 | 2.25 |
| 2004 | 2.18 |
| 2003 | 1.83 |
| 2002 | 2.01 |
It is evident in the computations that easyJet was always in better position to meet its short-term debt as compared to those of rivals in a peruse of the rivals’ current ratios. This means that easyJet is always bale to meet their current liabilities using their current assets (cash, inventory, receivables). The figures are not high so as to make the shareholders fear that the assets of the company are not working to grow the business, and not low so as to drive creditors away with respect to the level of risk present.
QUICK RATIO
As an alternative to the use of the current ratio, which may include financial statement items that are not easily liquidated and have uncertain liquidation values, the quick ratio does not include inventory in the computation of liquidity. In formula:
Current Assets – Inventory
QUICK RATIO = x 100
Current Liabilities
QUICK RATIO
| Years | % |
| 2006 | 2.43 |
| 2005 | 2.25 |
| 2004 | 2.18 |
| 2003 | 1.83 |
| 2002 | 2.01 |
Since quick ratios are perceived as a sign of the company’s financial strength or weakness, the figures in the previous table shows the relative stability of the financial strength of easyJet. A higher number would indicate stronger financial performance, and a lower one means weaker performance. Although there was a decrease in the 2003 ratio, the following year already showed signs of recovery and has continued up to last year.
FINANCIAL LEVERAGE RATIOS
The high financial leverage ratios of a company provide an implication that the organisation is solvent in the long-term. The following ratios are used to determine the financial leverage of easyJet:
Ø Debt Ratio; and
Ø Interest Coverage
Each of them are calculated for easyJet as follows:
DEBT RATIO
The debt ratio shows the company’s position to meet it long-term obligation or liabilities. Debt ratios are dependent of the company’s classification of long-term leases and other items as long-term debt. This is the gauge with which the financial strength of a company is a sign of the ratio of capital that has been funded by liability, counting preference shares.
DEBT RATIO
| Years | % |
| 2006 | 53.72 |
| 2005 | 52.13 |
| 2004 | 59.58 |
| 2003 | 67.26 |
| 2002 | 68.31 |
The formula for the debt ratio is:
Total Debt
DEBT RATIO = x 100
Total Assets
A higher debt ratio (which means the company has low equity ratio) does not give the firm’s creditors the security they require from an organisation. The firm would, as a result, find difficulty in raising supplementary financial support coming from outside sources if the firm wishes to take such action. Therefore it reveals that the higher the debt ratio, the harder it is for the company to raise funds from the outside. The table previous table shows that easyJet is decreasing their debt ratio as time passes, and that in itself is a positive indication for the credit standing of the company.
INTEREST COVERAGE
Interest coverage shows the company’s ability to pay the interest on its outstanding debts using the firm’s earnings. This is the number of times over that the company is able to meet its payments to their creditors. The figures to this ratio would imply the ability of the company to pay its obligations to external sources. The formula for its computation is shown below:
EBIT
INTEREST COVERAGE =
Interest Charges
INTEREST COVERAGE
| Years | % |
| 2006 | 4.89 |
| 2005 | 9.28 |
| 2004 | 24.04 |
| 2003 | 35.33 |
| 2002 | 14.69 |
ASSET MANAGEMENT RATIOS
A high turnover of assets means that the firm is able to use its assets efficiently to benefit the business. This has grave implications for stakeholders, as they would want the company’s assets to work for the business. The ratio used to determine the state of the asset management of easyJet is:
Ø Fixed assets turnover
It is calculated for easyJet as follows:
FIXED ASSETS TURNOVER (FAT)
The ratio for fixed assets determines easyJet’s ability to use its fixed assets in the generation of profits on a certain period of time. The formula for FAT is:
Sales
FAT = x 100
Net Fixed Assets
FIXED ASSETS TURNOVER (FAT)
| YEAR | % |
| 2006 | 1.56 |
| 2005 | 1.87 |
| 2004 | 1.70 |
| 2003 | 1.43 |
| 2002 | 1.02 |
The higher the turnover ratio for fixed assets, the more attractive the company is to investors, because it shows that the company is able to effectively use its fixed assets to generate profits for the shareholders. A too-low fixed asset turnover indicates that there may be assets owned by the company which could to be sold due to their apparent uselessness. The table shows that as years progresses, easyJet is able to continuously use its assets to the best interest of those involved.
THE DIRECTOR’S REPORT
The directors of easyJet, in making the financial reports of the company accept responsibility for the information contained in their announcements has been to ensure that such information has been correctly and fairly reproduced or presented. To the best of the knowledge and belief of the directors of easyJet (who have taken all reasonable care to ensure that such is the case), the information contained in all their financial reports which they accept responsibility is in accordance with the facts and does not omit anything likely to affect the import of such information. Certain of the information included in their releases is forward looking and is subject to important risks and uncertainties that could cause actual results to differ materially. It is not reasonably possible to itemise all of the many factors and specific events that could affect the outlook and results of an airline operating in the European economy. Among the factors that are subject to change and could significantly impact easyJet’s expected results are the airline pricing environment, fuel costs, competition from new and existing carriers, market prices for the replacement aircraft, costs associated with environmental, safety and security measures, actions of the Irish, U.K., EU and other governments and their respective regulatory agencies, fluctuations in currency exchange rates and interest rates, airport access and charges, labour relations, the economic environment of the airline industry, the general economic environment in the UK and Continental Europe, the general willingness of passengers to travel and other economics, social and political factors.
THE STATEMENT OF ACCOUNTING POLICIES
Accounting policies are the organisation’s unique set of principles with regards to its financial reporting practices. Based on general accounting conventions such as objectivity and prudence conventions, said practices must meet the terms of accounting standards such as the GAAP and the International Financial Reporting Standard (IFRS). Starting 2005, all firms in the European Union are required to implement the IFRS guidelines when making their financial statements, which complements with national accounting legislation (Atrill and McLaney 2004). Easyjet plc applied the UK GAAP prior to the EU directive to adopt the IFRS using the historical cost convention but immediately took measures to make sure that commencing financial year October 2005, the IFRS guideline is implemented. Some of the significant entries within the IFRS accounting policy are the value and the depreciation of easyJet’s aircrafts and the firm’s maintenance costs, among many others. Aircraft value was devalued over seven years to a residual value between ₤12million and ₤20million, depending on the type of aircraft. This basis on the historical cost convention takes into consideration a useful lifetime of twenty to thirty years for each of the company’s aircraft, and the high variance between the residual value of Airbus 319 and Boeing 737 resulted to more value mark down which has not been considered previously by easyJet. Maintenance costs which are obligatory for aircrafts which are leased were estimated to the bets of knowledge of the organisation but could possibly fluctuate highly.
THE FINANCIAL REPORTS[3]
The Income Statement of easyJet as for the year ended 30 September 2006 showed that the firm posted a profit before tax of £129.2 million, a 56% increase compared to 2005. easyJet’s revenue increased 20.7% from £1,341.4 million to £1,619.7 million, from financial year 2005 to financial year 2006. This is despite the firm’s fuel costs increasing by 49.0% from £260.2 million to £387.8 million from financial year 2005 to financial year 2006, evidence to the robustness of easyJet’s financial performance. easyJet continues to advertise to consolidate the awareness of the brand and its low fares philosophy, and expenses related to promoting the business has also risen by 16.4% from £32.8 million to £38.2 million from financial year 2005 to financial year 2006, which was greatly compensated by an 11.5% increase in the number of passengers, from £29.6 million in 2005 to £33 million last year.
The Balance Sheet remained strong with cash of £861 million and gearing at 31%. The Goodwill items in the balance sheet relates to the purchases of TEA Basel and Go Fly. Property, plant and equipment comprises principally owned aircraft, spares and deposits paid to Airbus in respect of the delivery of future aircraft which are not to be financed according to sale and leaseback arrangements. Other non-current assets comprise principally capitalised software and software development costs, restricted cash, deposits paid in respect of Airbus aircraft to be financed by sale and leaseback which deliver in more than one year. Current liabilities have increased by 22.8% principally due to the growth of the business, specifically the purchase of additional aircraft and application of license to fly in more routes.
The Cash Flow of the 2006 Annual Report shows that the company used up £353.7 million in capital expenditures for just the purchase of additional aircrafts to cater to the increasing number of flight passengers in the areas that they operate in, capital expenditure totaling to £408.3 million, if aircraft deposits, leasehold improvements and fixtures, fittings and equipment were to be included.
At 30 September 2006, net current assets were £578.2 million, up £101.8 million from £476.4 million at 30 September 2005. This change principally reflects an increase in cash, an increase in debtors due to increased sales volumes offset by an increase in creditors, while the number of shares allotted, called up and fully paid on 30 September 2006 was 410.5 million (2005: 400.4 million). During 2006,
10.1 million shares were issued on exercise of options under employee share option schemes (2005: 1.2 million).
THE SUPPORTING SCHEDULES AND NOTES TO THE ACCOUNTS
One of the supporting statements is the Consolidated Statement of Recognised Income and Expense, which presents cash flow hedges as income and expense recognised directly in equity valued at £20.3 million, which when subtracted from the profit for the year £94.1 million, will result to a £73.8 total recognized income and expense for the year attributable to the shareholders of easyJet. Notes to the accounts consisted of a section for the Net Financing Income, Taxation, Earnings Per Share, Goodwill, Other Intangible Assets and a host of other accounts which formed part of the financial statements (balance sheet, income statement and cash flow statement), and which were explained in detail in the section Notes to the Accounts to pave way for better understanding of the said financial statements by its users.
REVIEW OF THE 12 MONTHS TRADING
Following are some general factors that pertain to the 12-month trading activity of easyJet covered in the report. (1) Industry fundamentals with respect to customer demand or product / service pricing could change and adversely impact expected revenues and earnings; (2) Issues relating to major competitors or market shares or new product expectations could change investor attitudes toward the sector or this stock; (3) Unforeseen developments with respect to the management, financial condition or accounting policies or practices could alter the prospective valuation; or (4) External factors that affect the U.S. economy, interest rates, the U.S. dollar or major segments of the economy could alter investor confidence and investment prospects. Growth in easyJet airlines stocks were subject to the following risk factors: (1) changes in economic activity, (2) the outbreak and/or threat of war, (3) further terrorist attacks, (4) fuel price volatility, and (5) actions by major airlines.
The uncertainty surrounding easyJet shares is due to potential revenue weakness resulting from (1) over-capacity in the European airline industry; (2) the weakness in sterling against the euro; (3) easyJet's earnings are impacted by fuel price volatility. However, it has 90% of its fuel requirements hedged for the year under review. easyJet likes to compliment the high degree of business risk in the airline industry with low financial risk. This view is expected to continue and as such any share buyback or special dividend programme to still leave the company in an equity-weighted capital structure. easyJet claims that their Airbus order underpins their future growth and expects to increase capacity this year by 15%. Current trading is in line with easyJet’s expectations and they see yields for winter broadly in line with last year. As the civil aviation company looks further forward, the firm anticipates more pressure on yields in the summer due to continued aggressive competition. Remaining focused on improving execution and delivery of results by revenue enhancement, network development and cost reduction was always the target of easyJet for every trading period, but last year was seen as a very encouraging step towards improved return on equity. The Board remains confident that the business will make good progress in the coming years, based in the trading activity last year.
CONCLUSION
As a concluding note, annual impairment tests for sizeable fixed assets should lead to a better valuation of the business, which would result to a better view of the financial situation of the civil aviation company. Generally, the accounting policies of easyJet meet the IFRS and the aviation industry standards as well. Notwithstanding several critical but otherwise minor entries, it can be sufficiently agreed upon that easyJet’s accounts “give a true and fair view of the state of affairs” and consequently ”have been properly prepared” (easyJet 2006 p. 62). The results for the financial statements audit of easyJet done by PricewaterhouseCoopers LLP were evidently well-planned and performed the audit so as to obtain all the information and explanations which were considered necessary in order to provide the auditors with sufficient evidence to give reasonable assurance that the financial statements and the part of the Directors’ remuneration report to be audited are free from material misstatement, whether caused by fraud or other irregularity or error. In forming the opinion in this paper, the overall adequacy of the presentation of information in the financial statements and the part of the Directors’ remuneration report to be audited are also evaluated.
Building on the above analysis, it can be summarily said that easyJet is a company whose financial situation is stable and highly likely to improve in the years to follow. To sustain their development, the civil aviation firm should regularly assess the value of their portfolio of its business. They have to be positioned on fast-growing opportunities, whether geographically or by market segment through choosing to invest in businesses with long-term tail-wind profiles. If the current financial situation carries on consistently, easyJet would well achieve their vision of becoming the leader in their industry and a major player in each of their market segments and key geographical markets. The comparison of the past and present performance helped in bringing out pertinent bits of information which led to the conclusion that the UK offices and laboratories of Bureau Veritas adds value and contributes significantly to the progress of the firm as a whole.
REFERENCE
Atrill, P & McLaney, E 2004, Financial Accounting for Decision Makers, 4th edn., Prentice-Hall, New Jersey.
easyJet 2006 Annual Report 2007, easyJet Official Website, accessed 27 March 2007, from
Pike, R & Neale, B 1999,Corporate Finance and Investment Decision and Strategies, 3rd edn., Pearson Education Limited, England.
Riahi-Belkaoui, A 1998, Financial Analysis and the Predictability of Important Economic Events, Quorum Books, Westport, Connecticut.
[1] Information from this section came form the official company website unless otherwise indicated.
[2] Succeeding formulas come in part from http://www.hull.ac.uk/engineering/teaching/57048/exam/57048_0304.pdf.
[3] Information in this section came from the 2006 Annual Report.
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