GCE Business Studies Aer Lingus plc Ryannair Sample 8
GCE Business Study the information below and answer the questions that follow. The following are two public limited companies that operate within the transport sector of the Northern Ireland economy. Aer Lingus plc Aer Lingus plc, the national airline of the Republic of Ireland was founded in 1936 facilitating air transport between Ireland and the United Kingdom. Between 1950 and 1970 it expanded its operations to include destinations such as New York and Boston. During 2007, Aer Lingus plc commenced flights from Belfast International Airport to destinations such as London and Amsterdam. In the 1970s Aer Lingus plc diversified into computer processing, hotels personnel management, airframe maintenance and engine overhaul. Aer Lingus plc disposed of most of its ancillary business due to the pressures of the downturn of the global aviation industry during the 1990s. The Irish Government provided financial support to Aer Lingus plc with 222m in new equity. Aer Lingus plc has an issued share capital of 286.3m Ordinary 1.25 shares amounting to a total of 26.45m. A recent comment by stock-market analysts stated: company struggling to match 2001 sales and profits performance. Management should concentrate on making assets work. The company is quoted on the London and Dublin Stock Exchanges. Ryanair Ryanair is a budget airline operating from two of Northern Ireland s key airports (including Belfast City Airport and City of Derry Airport), offering a no frills service to a variety of European destinations. In 1985 Ryanair began scheduled flights between Waterford and Gatwick and by 1997, passenger numbers had reached over 3.1 million. Ryanair, under new management, embarked on a strategy of offering low fares and closing unprofitable routes. This led to Ryanair increasing its fleet of aircraft and offering an even greater choice of destinations for passengers. In July 1998, Ryanair announced that it was increasing its fleet of aircraft, by placing an order for 25 Boeing aircraft. Ryanair has an issued share capital of 1,547m Ordinary 0.0063 shares amounting to a total of 9.8m. A recent comment by stockmarket analysts stated: the dividend is uncovered [from earnings] in last three years. Profits graph is a little up and down in this industry sector. The company is quoted on the London and Dublin Stock Exchanges. 1
Table 1 (2006 Results) Company Aer Lingus plc Ryanair Financial Year ended: 31 December 2006 31 December 2006 m m Sales (Revenues) 1,115.8 1,692.5 Profit/(Loss) Before Tax (Operating (79.3) 338.9 Profit/(Loss)) Dividends 0.0 0.0 Retained Earnings (profit/loss) (69.9) 306.7 Non-current Assets 526.1 2,884.0 Current Assets 1,135.0 2,354.3 Total Assets 1,661.1 5,238.3 Share Capital and Reserves 552.7 2,086.9 Long Term Debt 462.5 2,033.7 Current Liabilities 645.9 1,117.7 Total Equity and Liabilities 1,661.1 5,238.3 Source: adapted from (i) Stock Market Annual 2008 (p.7 ); and (ii) Stock Market Annual 2008 (p.125 ); Published by Page7 Media, Dublin 18, Ireland. You may use this box for your workings: 2
(a) You are required to calculate the following accounting ratios for each company: 1. Return on Capital Employed [2] 2. Net Profit Margin [2] 3. Current Ratio [2] 4. Gearing [2] (b) Using the information above and the ratios calculated in part (a), discuss the financial position of Aer Lingus plc and Ryanair with respect to the following ratios: 1. Return on Capital Employed Ratio [3] 2. Net Profit Margin Ratio [3] 3. Current Ratio [3] 4. Gearing Ratio [3] (c) Evaluate the usefulness to investors, of using accounting ratios to assess the financial position of companies such as Aer Lingus plc and Ryanair. [12] 3
Suggested Solutions: 1 You are required to calculate the following accounting ratios for each company: 1. Return on Capital Employed: Aer Lingus Ryanair plc Profit/(Loss) Before Tax (79.3) 338.9 ---------------------- x 100% --------- x 100% ------x100% Total Assets-Current Liabilities 1015.2 4120.6 Return on Capital Employed: (7.8) % 8.2 % [2] 2. Net Profit Margin: Aer Lingus Ryanair plc Profit/(Loss) Before Tax (79.3) 338.9 ---------------------- x 100% --------- x 100% ----- x100% Sales 1,115.8 1,692.5 Net Profit Margin: (7.1) % 20.0 % [2] 3. Current Ratio: Aer Lingus Ryanair plc Current Assets 1,135 2,354.3 ---------------------- --------- -------- Current Liabilities 645.9 1,117.7 Current Ratio: 1.7 :1 2.1 :1 [2] 4. Gearing: Aer Lingus Ryanair plc Long Term Debt 462.5 2,033.7 ---------------------- x 100% --------- x 100% ------x100% Share Capital and Reserves + Long Term Debt 1015.2 4,120.6 Gearing: 45.5 % 49.35% [2] 4
(c) Using the information above and the ratios calculated in part (a), discuss the financial position of Aer Lingus plc and Ryanair with respect to the following ratios: 1. Return on Capital Employed Ratio This ratio measures the return in relation to the total amount of money invested in the business. The ratio indicates that for every 1 invested in the business Aer Lingus plc makes a loss of 0.078 and Ryanair earns a return of just over 0.082. By making a comparison between these two competitors Ryanair is making a return in relation to the total money invested in the business. Aer Lingus plc could improve its ROCE by increasing its operating profit, which in turn requires reductions in the cost of running the business. [3] 2. Net Profit Margin Ratio This ratio indicates the amount of net profit per 1 of sales that a business has earned. Aer Lingus plc makes a loss of 0.078 whereas Ryanair Holdings earns a return of just over 0.20. By making a comparison between these two competitors Ryanair is making a return in relation to the total sales of the business. Aer Lingus are making a financial loss on their sales suggesting a failure to control costs. This could also due to an inability of the company to generate sufficient revenues from its markets. Improvements in the net profit margin may be achieved through higher selling prices or cost reductions compared to competitors. [3] 3. Current Ratio As a rule of thumb a ratio of 2:1 is considered to be good. This means that the business has 2 worth of current assets for every 1 worth of current liabilities. The ratio tells us that Aer Lingus plc can meet its short term debts 1.7 times whereas Ryanair can meet its short term debts 2 times - a ratio of 2:1 in relation to the current liabilities in the business is acceptable. Conversely a lower ratio may mean that although current liabilities should be met in part, the business may be holding too few current assets. For example, a business may have too little cash, inventory levels may be too low, trade payables may be too high. To properly evaluate this ratio, it would require additional information regarding the make-up of current assets and monitored over time. [3] 4. Gearing This measure of a business s performance in relation to long term debts used to finance the business. The gearing ratio for Aer Lingus plc is 45.5% whereas for Ryanair Holdings it is 49.35%. By making a comparison between these two competitors both companies have debt levels under 50% of the total capital employed. Whilst both companies have low gearing levels, this 5
suggests that their vulnerability to increases in interest rates is minimal. However, this may be considered acceptable in such businesses as they may be funding expansion programmes and generating high profit levels. The companies can improve their gearing by repaying long term loans, issuing more ordinary shares or redeeming debentures. [3] Level 3 AO1 Knowledge & Understanding 4 marks very good understanding of the financial position. makes good use of specialist vocabulary when it is appropriate. AO2 Application 4 marks demonstrates very good application of knowledge AO3 Analysis 4 marks Very good analysis of financial position, using accounting ratios. Level 2 Level 1 Level 0 good understanding of the financial position. makes good use of specialist vocabulary when it is appropriate. some understanding of the financial position. makes some use of specialist vocabulary when it is appropriate. no understanding of the financial position. does not make use of specialist vocabulary when it is appropriate. demonstrates good application of knowledge. attempts to apply knowledge. does not attempt to apply knowledge. Good analysis of financial position, using accounting ratios. Limited analysis of financial position, using accounting ratios. No analysis of financial position, using accounting ratios. (c) Evaluate the usefulness to investors, of using accounting ratios to assess the financial position of companies such as Aer Lingus plc and Ryanair. Advantages Gives an indication if there are any problems concerning any areas e.g. performance, profitability, liquidity, gearing Quantitative measures facilitate assessment of the financial performance of the business across a range of areas. Comparisons can be made regarding financial performance over time 6
Comparisons can be made regarding financial performance relative to other businesses, other investments Can be used in addition to variance analyse to evaluate attainment of performance targets. Disadvantages May be difficult to make comparisons with similar businesses due to different accounting policies Ratios are only as accurate as the underlying information in financial statements, thus subject to manipulation and seasonal factors Analysis limited to quantitative issues, proving little information regarding rivals etc. Ignores qualitative issues in broader business environment and non-finical indicators, e.g. goodwill, reputation, quality, staff turnover/wider economic indicators Only in expressed in numerical terms do not provide reasons/explanations Ratio analysis may not apply / be relevant in certain circumstances [12] Level 3 A01 Knowledge and Understanding very good understanding of the usefulness to investors of accounting ratios. makes excellent use of specialist vocabulary when appropriate. A02 Application demonstrates Very good application of knowledge. A03 Analysis Very good analysis A04 Evaluation gives a full evaluation of the usefulness to investors of accounting ratios and comes to a final judgement. demonstrates very good spelling, punctuation and grammar. The meaning of the text is clear. The candidate has consistently used a form and style of writing appropriate to the purpose of the question. Answer is organised in a clear and coherent manner. 7
Level 2 Level 1 Level 0 an adequate understanding of the usefulness to investors of using accounting ratios. makes adequate use of specialist vocabulary when appropriate. 1 Mark limited understanding of the usefulness to investors of accounting ratios. makes limited use of specialist vocabulary when appropriate. no understanding of the usefulness to investors of accounting ratios. adequately applies knowledge 1 Mark attempts to apply knowledge. does not attempt to apply knowledge. Adequate analysis of limitations. 1 Mark Limited analysis of limitations. does not analyse the limitations. gives an adequate evaluation of the usefulness to investors of using accounting ratios and comes to a final judgement. demonstrates adequate spelling, punctuation and grammar. The meaning of the text is clear most of the time. The candidate demonstrates an adequate level of writing form and style appropriate to the purpose of the question. The answer is organised in a satisfactory manner. 1 Mark provides a limited evaluation of the arguments presented. makes limited use of spelling, punctuation and grammar. The meaning of the text is not always clear. The candidate demonstrates a limited form and style appropriate to the question. The organisation of the answer is limited. makes no attempt to evaluate the usefulness of accounting ratios presented. 8