Financial Analysis- Subject: Finance & Accounting

 

Question 1.

The liquidity and profitability ratios are essential in giving insight into the current

financial performance of Southwest Airlines. The liquidity ratios like the quick ratios and the

current ratio assure whether a firm can settle the current debts obligations. On the other hand,

profitability ratios include the net profit margin, operating profit margin, and the return on total

assets (Hitt et al., 2017). These ratios are critical in ascertaining whether Southwest Airlines is

generating enough profits to finance its expenses.

One can determine whether the calculations yield positive or negative results through the

general rule that any ratios surpassing 1.0 are positive while ratios below 1.0 are negative. In

addition, one can rule out a negative outcome by comparing ratios obtained by the industry

averages. Some ratios that can indicate an area of concern regarding the current Southwest

Airlines strategy include the low liquidity ratios, low profitability ratios, high leverage ratios, or

low activity ratios.

Low liquidity ratios, marked by ratios below 1.0, indicate that Southwest Airlines cannot

meet short-term financial obligations accruing to the firm. Cases of low operating profit margin

and low net profit margin can suggest that the Airline is obtaining reduced income from various

operations conducted by the Airline. The low-profit margin and low net profit margin can also

indicate that the Airline is making losses. Regarding the activity ratios like low total asset

turnover, the ratio suggests that the current Southwest Airlines strategy is underutilizing the

firm's assets. The underutilization of the company assets challenges the ability of the firm to

generate revenues effectively. The high leverage ratios, which are also critical in the evaluation

of the Airline, indicate the firm is operating on negative net worth. These ratios help inform that

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the financing of Southwest Airlines is through debt. The percentages help ascertain any

ineffectiveness of the Airline's strategy and the likelihood of running bankrupt or seizing to

operate.

Question 2.

A strategic alliance within the field of business refers to a mutual agreement between two

or more firms to work together to achieve shared objectives. The coalition is key to realizing the

shared goals, which would otherwise be unattainable if one firm was to commit to the objectives

independently. Through a strategic alliance that enjoys different benefits, the alliance is also

prone to some risks. If Southwest Airlines were to enter into a strategic partnership based on

profitability ratios, it would be inclined to some risks.

            Some of the risks of forming alliances based on the firm's profitability ratios include the

firm's size, timing problems, and failure to consider long-term strategies of the firm. In regards to

the organization's size, small firms tend to record higher profitability ratios than larger firms.

However, in a real sense, larger businesses are more profitable compared to smaller firms. In

regards to the timing problem, the profitability of some firms is based on seasonal factors. This

situation means that the ratios might be below at different times, while at other times, the

business might record low ratios. The timing risk also indicates that the services or products of

the company might be profitable at a particular time while also at risk of being absolute in the

future. Another threat to forming strategic alliances based on profitability ratios is that

profitability ratios do not consider the prevailing long-term activities of the organization that

might deem it profitable in the future.

Amongst the five ratios, leverage ratios are the most likely to show immediate information to

analyze the effectiveness of a strategic alliance. The leverage ratios outline the sources of the

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organization's capital, either from shareholder equity or debt. The balance is also essential in

providing a long-term outline regarding the financial position of the organization.

Question 3.

As the COVID pandemic ravages different economies globally, it makes it difficult for

Southwest Airlines to obtain capital to fund an aggressive value-enhancement strategy. The

traveling business has been highly affected by the travel restrictions and risk for spreading the

virus, which has seen a reduction in the number of travelers. Under this type of environment,

creditors are demanding assurances and well-thought strategies that will guarantee the creditors'

support. Capital for financing a value-enhancement plan can, however, be obtained from private

equity loan lenders. Based on the prevailing interest rates, an interest rate of 3% would be better.

The quick ratios will be affected by the inflow of capital as this ratio indicates the capability of

the business to settle short-term debt obligations.

Part Two

Calculations for Southwest Airline Financial ratios based on the financial data posted by

(Southwest Airlines, 2020) annual 2020 report to shareholders.

A1.

 Return Total Assets = Profits after taxes/Total assets

3074\34,588 =0.088

At 8.88%, it indicates that the Airline enjoys a good return on its asset investment. Over 20%

percent ROA would suggest that the firm is excellently utilizing its assets to generate profit.

A2. 

Current Ratios = Current assets/ Current Liabilities (Amount in Millions)

15,173/ 7506 = 2.02

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A current ratio between 1.5 to 3.0 generally indicates a good percentage indicating the firm's

ability to cater to its current financial liabilities.

A3. 

Debt-to-assets = Total debt/ Total assets

10,111/34,588 = 0.29

The ratio indicates that 29% of Southwest Airline assets have been financed through borrowing.

A4.

 Total Assets Turnover = Sales/ Total assets

4336/34,588 = 0.125

The ratio indicates that Southwest Airlines generated $ 0.125in sales for every $1 in total assets.

This result means that there is inefficiency in the ability of the firm to use its assets to generate

sales.

A5.

Dividend Pay-out Ratio = Annual dividends per share/ After tax earnings per share

0.180/5.44 = 0.0033

The results mean that Southwest Airlines pays 3.3% of its net income to the firms' shareholders

while re-investing 96.75% to the business.