UNIT -1: AIRLINE FINANCE

Airline financial management is a multifaceted challenging task. Most of the airlines rely on the
conventional MS Excel to generate various financial statements. Selecting and implementing the right
solution for cash management is the key challenge the airlines often face. Today, many airlines are availing
Treasury Management System (TMS) that provides finance handling solutions.

Now 5 reasons why Finance is important in today’s business?

Managing finances is a very important business aspect of today, which means having a chance to work
toward a stable and rewarding career in financial management field. Financial planning helps in deciding
what to spend, when to spend, how to spend and how much to spend according to the funds availability.
Here are the below given 5 reasons on importance of finance in today’s business such as –

1. Without financial management business cannot exists

In today’s business economy, Small businesses and Entrepreneurship are more on rise that means more
positions for financial managers will continue to become much more available. Without ineligible person
responsible to manage the incoming and outgoing of money a good business cannot exist.

As good business generates money, through this generated money paying bills for materials, payment of
salary for the employees in an organization are done. Good business earnings happen by selling quality
services or products. Managing financial aspects plays a very vital role in progress of any good business.

2. Adequate funds availability

Sufficient funds are necessary to meet daily expenses to purchase long term assets for the company’s
requirement accordingly; also funds should be there to deal with future unforeseen over costs which may
arise. The company should know from where the funds have to be raised and when it should be needed in
emergency to deal the monetary crisis.

3. Cash flow management system

In an organization, excess cash flow can also become difficult to manage. Having excess amount of funds
and not using it in a genuine much useful way is a greater waste of resources. When an organization is
having adequate funds they should put it in good

yielding investments by thinking very wisely. And also make sure that they have expansion future plans and
think about new ventures which will gain them huge profits to earn for the long run.

4. Always keeping long term goals

Having long term goals in life or business is a very important aspect to keep, once it is done the
responsibility has to be fulfilled as per the plan made at any cost to get fulfil the targeted goals to achieve
success. In any business entity, financial planning is a process of engaging a proper financial plan to meet its
financial goals in a specific time period.

To have long term financial goals in a business is a very important part, were by doing this many upcoming
financial crises in future can be resolved without any hassle. It is always a good idea to have an early well
planning goal, especially in finance since investing on any good options may earn high returns over the
period of time to the company to gain financial stability. So investing money with good thoughtful planning
from now will make easier to execute such long term goals.

5. Financial Planning value and importance in a business

Financial planning creates immense value to the company, without this any of the business entity cannot
function properly. It is a major vital venture for all kinds of businesses worldwide. It is done for an entire
year to have control over financial activities of the company. The bigger the company, the bigger will be the
size of the team working on financial planning and the greater skilled professionals needed.

Financial planning needs the entire support of accurate financial analysis and reporting. It has to be done
continuously, with this the outcome of the plan also need to be monitored regularly. In any case the
approved plan is not working, then the plan has to be modified instantly or new plan has to be made and
adopted with immediate effect to run the business successfully without any kind of hindrance occurring in
between.

Need of finance in business.

Finance is the money available to spend on business needs.

Right from the moment someone thinks of a business idea, there needs to be cash. As the business grows
there are inevitably greater calls for more money to finance expansion. The day to day running of the
business also needs money.

The main reasons a business needs finance are to:

1. Start a business

Depending on the type of business, it will need to finance the purchase of assets, materials and employing
people. There will also need to be money to cover the running costs. It may be some time before the
business generates enough cash from sales to pay for these costs. Link to cash flow forecasting.

2. Finance expansions to production capacity

As a business grows, it needs higher capacity and new technology to cut unit costs and keep up with
competitors. New technology can be relatively expensive to the business and is seen as a long term
investment, because the costs will outweigh the money saved or generated for a considerable period of time.
And remember new technology is not just dealing with computer systems, but also new machinery and tools
to perform processes quicker, more efficiently and with greater quality.

3. To develop and market new products

In fast moving markets, where competitors are constantly updating their products, a business needs to spend
money on developing and marketing new products e.g. to do marketing research and test new products in
"pilot" markets. These costs are not normally covered by sales of the products for some time (if at all), so
money needs to be raised to pay for the research.

4. To enter new markets

When a business seeks to expand it may look to sell their products into new markets. These can be new
geographical areas to sell to (e.g. export markets) or new types of customers. This costs money in terms of
research and marketing e.g. advertising campaigns and setting up retail outlets.

5. Take-over or acquisition

When a business buys another business, it will need to find money to pay for the acquisition (acquisitions
involve significant investment). This money will be used to pay owners of the business which is being
bought.
 6. Moving to new premises

Finance is needed to pay for simple expenses such as the cost of renting of removal vans, through to
relocation packages for employees and the installation of machinery.

7. To pay for the day to day running of business

A business has many calls on its cash on a day to day basis, from paying a supplier for raw materials, paying
the wages through to buying a new printer cartridge.

8. Choosing the Right Source of Finance

A business needs to assess the different types of finance based on the following criteria:

Amount of money required – a large amount of money is not available through some sources and the other
sources of finance may not offer enough flexibility for a smaller amount.

How quickly the money is needed – the longer a business can spend trying to raise the money, normally
the cheaper it is. However, it may need the money very quickly (say if had to pay a big wage bill which if
not paid would mean the factory would close down). The business would then have to accept a higher cost.

The cheapest option available – the cost of finance is normally measured in terms of the extra money that
needs to be paid to secure the initial amount – the typical cost is the interest that has to be paid on the
borrowed amount. The cheapest form of money to a business comes from its trading profits.

The amount of risk involved in the reason for the cash – a project which has less chance of leading to a
profit is deemed riskier than one that does. Potential sources of finance (especially external sources) take
this into account and may not lend money to higher risk business projects, unless there is some sort of
guarantee that their money will be returned.

The length of time of the requirement for finance - a good entrepreneur will judge whether the finance
needed is for a long-term project or short term and therefore decide what type of finance they wish to use.

Airline Costs

Any airline needs to deal with the following types of costs −

Start-up Costs

 Capital investment
 Inventory costs

Operating Costs

 Fuel cost
 Labour cost
 Employee cost

Depreciation Costs

 Aircraft spares cost

Airline Cash Management

Cash management is tackled with the help of cash forecasting or cash budgeting. Forecasting is done either
Short Term, or Long Term.

Purpose of Airline Cash Forecasting

Short-tern cash forecasting is used to accomplish the following −

1. Determine operating cash requirements.

2. Anticipate the need for short-term cash requirements.
3. Invest any surplus cash wisely.
4. Maintain cordial relations with banking partners.
5. Long-term detailed cash forecasting is used to appraise proposed projects that require working
capital and avail loans whenever required.

Airline Cash Forecasting Methods

The following are the different types of forecasting methods −

1. Casual Forecasting − It is derived from analysing the statistical relationship between dependent
variable against independent variable. For example, analysing trends.
2. Trend Forecasting − The changes of dependent variable are judged with respect to time. This helps in
anticipating time-related changes.
3. Cyclical Variations − These are the changes in cash flow due to business cycles.

4. Seasonal Variations − These are the changes in cash flow due to a specific time period in the year.
5. Irregular Variations − These are the changes in cash flow due to erratic events such as strikes, wars,
price wars, bankruptcies, or any other disturbance.

Airline Finance – Overview

The following are the four basic factors in airline finance management −

1. Income Statement − It is a report that shows business managers and investors whether the airline
made or lost money during the specific period.
2. Cash Flow Statement − It provides information on cash receipts and payments, and the net change in
cash due to operating, investing, and financing activities of an airline during the period.
3. Stockholders’ Equity Statement − It is a record of the current equity stake held by the airline’s
investors.
4. Balance Sheet − It gives an idea about the financial position of the airline at a given point of time. It
reflects what the airline owns as well as how much it owes.

Fuel and Currency Hedging

Airlines are extremely exposed to the changes in aviation fuel or jet fuel costs. A slightest change in the fuel
prices can affect the airline business finance and operations. To deal with fuel price changes, the airlines use
a tool named Fuel Hedging.

What is Fuel Hedging?

It is a contract that the airlines use to protect themselves from the changes and rise in fuel rates. The cost of
fuel hedging depends on the forecasted price of fuel. The airlines enter into hedging contracts with fuel
companies to establish a fixed price of the fuel. In future, if the fuel price increases than their contracted
price, the airline is forced to pay the contracted price. If the price of fuel decreases than the current fuel
price, then the airline receives the price difference from the fuel company.

Who provides fuel hedging service?

The fuel management companies, oil companies, and financial service companies provide fuel hedging
service to the airlines. For example, World Fuel Service, British Petroleum, Morgan Stanley, and BNP
Paribas.

Airline Revenues

With fierce competition in the aviation industry, the airlines come up with ideas of generating revenues in
various ways. They study the customers and their needs, the competitors, reduce the airfare to attract new
customers and keep the existing ones loyal. They also generate revenue from ancillary products and
services.

Airline Taxes and Fees

Apart from the ticket price, they are the charges for fuel surcharge and service tax.

À la Carte Pricing Policy

It is a new pricing approach to let the customer choose the ancillary product or service and pay for it. For
example, buying meals, snacks, and drinks on board that was traditionally part of the ticket. Also, the Low
Cost Airlines offer their customer priority boarding or to select the seat of their choice and pay for it.

Add-on Services for Travel

The ancillary services such as pick-up and drop-off services to and fro from the customer’s residence and
ticket bookings for special events at destination are offered as a part of ticket booking.

On-board Sale

It means the sale of duty-free items such as jewellery, liquor, tobacco, electronic gadgets, and perfumes. The
airlines have come up with a wide range of electronic items, kitchen items, travel items, and gift items for
sale on board. It is also extended to discount cards, credit cards, and direct marketing catalogues.

Advertising Sales

Conventionally, airlines only advertised themselves through their magazines distributed in-flight. Now,
through their own airline websites they generate considerable opportunities for advertising revenue. The
website is a gateway to reach the potential air travellers via hotels, car-rental companies, and travel-
insurance providers where they look for travel options.

What is PE ratio? Performance earnings ratio

PE ratio is a metric that compares a company’s current stock price to its earnings per share, or EPS, which
can be calculated based on historical data (for trailing PE) or forward-looking estimates (for forward PE).
It's a standard part of stock research investors use to:

 Compare the stock prices of similar companies to find outliers.

 Determine if the stock is undervalued, appropriately priced or overvalued.
 Decide, based on its value, if they should buy, sell or hold any particular stock.

PE ratio example
Here’s one scenario: A company posts stable profits quarter after quarter, and its projected profits are
equally stable. If its stock price jumps but its earnings stay the same (and no earnings increases are
expected), the company’s intrinsic value didn’t change; the market’s perception of the company did.

In this instance, the earnings in the PE ratio stayed the same, while the price soared, which mathematically
sends the overall PE ratio higher. If a company’s PE ratio is significantly higher than its peers, there’s a
chance the stock is overvalued.

Another way to understand PE ratio: It’s a measure of how much investors are paying for every $1 of a
company’s earnings. Imagine two similar companies in the same sector. One has a share price of $100 and a
PE ratio of 15. The other has a share price of $50 and a PE ratio of 30. The first company’s share price may
be higher, but a PE ratio of 15 means you’re only paying $15 for every $1 of the company’s earnings.
Investors in the company with a PE ratio of 30 are paying $30 for $1 of earnings.

Solvency Ratio

Solvency ratios are a key component of the financial analysis which helps in determining whether a
company has sufficient cash flow to manage the debt obligations that are due. Solvency ratios are also
known as leverage ratios. It is believed that if a company has a low solvency ratio, it is more at the risk of
not being able to fulfil its debt obligation and is likely to default in debt repayment.

Solvency ratios are used by prospective business lenders to determine the solvency state of a business.
Companies that have a higher solvency ratio are deemed more likely to meet the debt obligations while
companies with a lower solvency ratio are more likely to pose a risk for the banks and creditors.

Solvency ratios vary with the type of industry, but as a good measure a solvency ratio of 0.5 is always
considered as a good number to have.

Solvency ratios should not be confused with liquidity ratios. They are totally different. Liquidity ratios
determine the capability of a business to manage its short-term liabilities while the solvency ratios are used
to measure a company’s ability to pay long-term debts.

Financial Ratio Analysis for Stock market and Investor

1. Earnings Per Share (EPS)

EPS is the first most important ratio in our list. It is very important to understand Earnings per share (EPS)
before we study any other ratios, as the value of EPS is also used in various other financial ratios for their
calculation.

EPS is basically the net profit that a company has made in a given time period divided by the total
outstanding shares of the company. Generally, EPS can be calculated on an Annual basis or Quarterly basis.
Preferred shares are not included while calculating EPS.

Earnings Per Share (EPS) = (Net income – Dividends from preferred stock) / (Average outstanding
shares)

From the perspective of an investor, it’s always better to invest in a company with higher and growing EPS
as it means that the company is generating greater profits. Before investing in any company, you should
always check past EPS for the last five years. If the EPS is growing for these years, it’s a good sign and if
the EPS is regularly falling, stagnant or erratic, then you should start searching for another company.

2. Price to Book (PBV) Ratio

Price to Book Ratio (PBV) is calculated by dividing the current price of the stock by the book value per
share. Here, Book value can be considered as the net asset value of a company and is calculated as total
assets minus intangible assets (patents, goodwill) and liabilities. Here’s the formula for PBV ratio:

Price to Book Ratio = (Price per Share) / (Book Value per Share)

PBV ratio is an indication of how much shareholders are paying for the net assets of a company. Generally,
a lower PBV ratio could mean that the stock is undervalued.

However, again the definition of lower varies from industry to industry. There should be an apple to apple
comparison while looking into PBV ratio. The price to book value ratio of an IT company should only be
compared with PBV of another IT company, not any other industry.

3. Debt to Equity (DE) Ratio

The debt-to-equity ratio measures the relationship between the amount of capital that has been borrowed
(i.e. debt) and the amount of capital contributed by shareholders (i.e. equity).

Debt to Equity Ratio = (Total Liabilities) / (Total Shareholder Equity)

Generally, as a firm’s debt-to-equity ratio increases, it becomes riskier as it means that a company is using
more leverage and has a weaker equity position. As a thumb of rule, companies with a debt-to-equity ratio of
more than one are risky and should be considered carefully before investing.

4. Return on Equity (ROE)

Return on equity (ROE) is the amount of net income returned as a percentage of shareholders’ equity. ROE
measures a corporation’s profitability by revealing how much profit a company generates with the money
shareholders have invested. In other words, ROE tells you how good a company is at rewarding its
shareholders for their investment.

Return on Equity = (Net Income)/ (Average Stockholder Equity)

As a thumb rule, always invest in a company with ROE greater than 20% for at least the last 3 years. Year-
on-year growth in ROE is also a good sign.

5. Price to Sales Ratio (P/S)

The stock’s price/sales ratio (P/S) ratio measures the price of a company’s stock against its annual sales. P/S
ratio is another stock valuation indicator similar to the P/E ratio.

Price to Sales Ratio = (Price per Share)/ (Annual Sales Per Share)

The P/S ratio is a great tool because sales figures are considered to be relatively reliable while other income
statement items, like earnings, can be easily manipulated by using different accounting rules.

6. Current Ratio

The current ratio is a key financial ratio for evaluating a company’s liquidity. It measures the proportion of
current assets available to cover current liabilities. The current ratio can be calculated as:

Current Ratio = (Current Assets)/ (Current Liabilities)

This ratio tells the company’s ability to pay its short-term liabilities with its short-term assets. If the ratio is
over 1.0, the firm has more short-term assets than short-term debts. But if the current ratio is less than 1.0,
the opposite is true and the company could be vulnerable. As a thumb rule, always invest in a company with
a current ratio greater than 1.

7. Dividend Yield

A stock’s dividend yield is calculated as the company’s annual cash dividend per share divided by the
current price of the stock and is expressed in annual percentage. Mathematically, it can be calculated as:

Dividend Yield = (Dividend per Share)/ (Price per Share) *100

For Example, If the share price of a company is Rs 100 and it is giving a dividend of Rs 10, then the
dividend yield will be 10%.

A lot of growing companies do not give dividends, rather reinvest their income in their growth. Therefore, it
totally depends on the investor whether he wants to invest in a high or low dividend yielding company.
Anyways, as a thumb rule, consistent or growing dividend yield is a good sign for dividend investors.