2. Short-term liquidity Liquidity reflects the ability of a firm to meet its short-term obligations using assets that are most readily converted to cash. Short-term is usually considered as in 12 months or an operating cycle of a business. Assets that may be converted into cash in a short period of time are referred to liquid assets, which are recognised as current assets in financial statements. They are used to satisfy short-term obligations, or current liabilities. Liquidity is important because of changing business operation. A business must be able to pay its financial obligations when needed.
Otherwise, it will go bankrupt. We can assess the liquidity of a business by calculating these ratios: Current ratio, Quick asset ratio. Besides, we also study Average settlement period for Accounts receivable to know more about a source to pay short-term liabilities. For Air New Zealand, we apply ratios as following: Current ratio Currnet ratio= Currnet AssetsCurrent Liabilities | 2008| 2009| 2010| Current ratio (times)| 1. 25| 1. 29| 1. 05| Normally, the higher current ratio, the more liquid the company is considered to be. In the case of Air New Zealand, it was just only higher a little than 1. . Meanwhile, although the ratio slightly increased from 2008 to 2009, but over 3 years it reduced by 16%, which is equivalent to 0. 2 times, from 1. 25 to 1. 05 times. The main reason was the decrease of current assets from 2,127 million dollars in 2008 to 1,688 million dollars in 2010. This means that ability of the company to pay its immediate financial obligations was low and generally decreasing. Quick asset ratio Quick asset ratio= Currnet Assets-InventoriesCurrent Liabilities | 2008| 2009| 2010| Quick asset ratio (times)| 1. 17| 1. 21| 0. 95|
In the case of Air New Zealand, quick asset ratio is more suitable than current ratio to evaluate liquidity of the company because its main business type is supplying service, not manufacturing or trading therefore it does not have much value of inventories. The biggest proportion in current assets of the company is “Bank and short-term deposit” because its strong cash flows. Quick asset ratio in 2008 and 2009 showed that Air New Zealand’s liquid assets could cover well current liabilities because it was higher than 1. 0. However, it fell down considerably in 2010 and was less than 1. 0.
This indicates that the company had a liquidity problem in 2010. Not only due to reason as in changes of current ratio, but also consistent increase of inventories at the end of each year affected changes of quick asset ratio. However, both current ratio and quick asset ratio are just relevant to figures on the balance sheet. Therefore, they only assess liquidity of Air New Zealand at a point of time. In order to understand more about the ability to clear short-term debt, we consider the average settlement period for Accounts receivable. Average settlement period for Accounts receivable (debtors)
Average settlement period= 365 daysAccounts receivable turn over | 2008| 2009| 2010| Average settlement period (days)| 37. 15| 31. 36| 32. 48| This figure shows that the average length of time Air New Zealand collected debtors is a quite short time, just only more than 1 month. It is due to the company’s field of business operation that is airlines transport and majority customers are individual consumers paying immediately when using the company’s services. Moreover, the average settlement period shortened quickly from 37. 15 days in 2008 to 31. 36 days in 2009 then only lengthened a little to 32. 8 days in 2010. Thereby, the company could use collection of debtors to pay immediate obligation quicker and quicker. 3. Long-term financial stability Long-term financial stability of a business is also referred to the gearing or leverage. It is an important issue which both managers and outside parties, suppliers for example, always concern. Gearing occurs when a business is financed from outsides. In other words, the business has debts. Financing through debt involves risk because it legally obligates the company to pay interest and the principal as promised.
Not only managers must consider risk when making financial decision but also outside parties know about the company’s ability to pay debts. There are two types of financial gearing ratios, which are used to assess how much financial risk the company has taken on, are: Gearing ratio (or Component percentages) and Interest coverage ratio. For Air New Zealand, we apply ratios as following: Gearing ratio: Gearing Ratio=Total LiabilitiesTotal Assets | 2008| 2009| 2010| Gearing ratio| 68. 60%| 68. 19%| 65. 93%| In general, the gearing ratio of Air New Zealand in three year was higher than 65%.
It means proportion of total liabilities in total fund (or total assets) used in Air New Zealand was higher than 2/3 which is a high gearing level. However, gearing level of Air New Zealand in 3 years decreased from 68. 60% in 2008 to 68. 19% in 2009 and 65. 93% in 2010. This is a good sign of using fund in Air New Zealand. In fact, although main trend of both total fund and total liabilities employed in operation of the company were to go down, but value of total liabilities reduced faster than total fund, from 3,446 to 3,031 million dollars after 3 years. This is essential factor that made changes of gearing ratio.
Interest coverage ratio Interest cover Ratio= Profit before interest and taxationInterest expense | 2008| 2009| 2010| Interest cover ratio (times)| 2. 09| 0. 46| 2. 13| This ratio shows that how many times level of profit higher than interest expense or availability of profit to cover interest expense. The ratio was always less than 3, demonstrating that borrowed fund on each dollar of profit was quite expensive in generating profit of Air New Zealand and financial expense was a burden on business operation of the company. Simultaneously, the ratio fell down significantly from 2. 9 times in 2008 to 0. 46 times in 2009, and then recovered to 2. 13 times in 2010. These were high fluctuation amplitude in just 3 years. In fact, not only financial expense reduced year by year from 172 in 2008 to 169 in 2009 and 71 in 2010 million dollars, but also ratio of financial expenses to total revenue decreased from 3. 69%, 3. 67% and 1. 75% in 2008, 2009 and 2010 respectively. However, profit before interest and tax of the company declined considerably after 3 years from 359 to 151 million dollars, especially was at the bottom in 2009 with 78 million dollars only.
It made changes of the ratio. This information is notable to lenders of The Air New Zealand because it shows risk to them. Besides, the lenders should consider real monetary availability of the company, which will be deeply investigated later in Analysis on the cash flow statement. 6. Analysis on the cash flow statement We can extract some notable information from the cash flow statement of Air New Zealand as following: | 2008(Million dollars)| 2009(Million dollars)| 2010(Million dollars)| Net Cash flow from operating activities| 743. 00| 486. 00| 334. 0| Net cash flow from investing activities| (290)| (216)| (450)| Net cash flow from financing activities| (221)| 14| (390)| Receipts from customers| 4,735. 00| 4,595. 00| 4,135. 00| Payments to suppliers and employees| 4,093. 00| 4,122. 00| 3,627. 00| Acquisition of property, plant, equipment| 274. 00| 318. 00| 433. 00| Dividend on ordinary shares| 100. 00| 63. 00| 65. 00| Obviously, Air New Zealand’s source of cash was from operating activities. Net cash flow from investing and financing activities were almost less than 0. This means that the company could not collect money from its investing and financing operations.
Although money paid to suppliers and employees went down from 2008 to 2010, receipt the company collected from customers decreased faster and constantly over 3 years. This primarily leaded net cash flow from operating activities reduced from 743 million dollars in 2008 to 334 million dollars in 2010 nearly a half of 2008. Meanwhile, dividends paid to ordinary shareholders decreased from 100 million dollars in 2008 to 63 million dollars in 2009 and 65 million dollars in 2010, a two third of 2008. However, it is notable that payment for acquisition of property, plant, equipment went up constantly from 274 million dollars in 2008 to 433 million ollars in 2010. The figures show that Air New Zealand purchased more and more new equipments to aim for the future. This can lead to money shortage of the company. In order to have further observation, we calculate the formula: Net Cash flow from operation-Purchases of new equipment-Dividends paid The result was 369, 105 and (164) million dollars in 3 years respectively. This indicates that available cash of the company gradually reduced. Especially, the figure was less than 0 in 2010. It means that the company had insufficient money for business operation in long term.