Ratio Analysis Business Analytics

BUSINESS ANALYTICS

Business Analytics: Ratio Analysis

The ratios captured in Table 1 below would come in handy in efforts to assess Southwest Airline’s current performance level.

Ratios

Formula

Profitability Ratios:

i. Return on Total Assets (ROA)

ii. Return on Stockholder’s Equity (ROE)

Profits after Taxes/Total Assets

Profits after Taxes/Total Stakeholder’s Equity

= -0.35

Liquidity Ratio: Current Ratio

Current Assets/Current Liabilities

Leverage Ratio: Debt-to-Assets Ratio

Total Debt/Total Assets

Activity Ratio: Total Assets Turnover

Sales/Total Assets

Shareholders’ Return Ratio: Dividend Payout Ratio

Annual Dividend Per Share/After-Tax Earnings Per Share

0.18/-5.44 =

Table 1

NB: Figures in thousands (except financial ratio computations ratios, EPS and DPS)

Discussion

It would be prudent to note that as per the most recent financial statements of Southwest Airlines, an assessment of the various ratios indicate that the airline performed better in the year under consideration (2021) than it did in the previous year (2020). This is more so the case with regard to the return on assets ratio and return on equity ratio. Thus, in addition to having improved its efficiency in as far as the utilization of its assets in profit generation (as indicated by growth in return in total assets) is concerned, the airline also managed to increase the profits earned for every dollar that stockholders have invested (as indicated by growth in return on equity). This is essentially an indication of an airline or commercial enterprise recovering from the negative impact of the COVID-19 pandemic. The liquidity and leverage ratios are within acceptable limits – an indication that there is no risk of the airline defaulting on its obligations – both short-term and long-term.

In essence, the formation of strategic alliances has certain risks and benefits. There would be need for Southwest Airlines to be cognizant these risks and benefits if it seeks to form a strategic alliance. When it comes to risks, Southwest Airlines might report a lower return on assets ratio going forward if there is lack of coordination between management teams following the formation of the strategic alliance. This is more so the case given that the firm would likely find it difficult to engage in the effective management of available assets to generate profits. The fact that there is risk of financial resource control also means that the airline’s bottom-line could be negatively impacted – resulting in a lower ROE ratio. The airline is not out of the woods yet after reporting a negative ROA as well as ROE in the year 2020, and a low ROE and ROA in the year 2021.

The alliance’s effectiveness is most likely to be revealed by return on equity ratio going forward. Hitt, Ireland and Hoskisson (2016) define return on equity as a measure of “how profitably the company is utilizing shareholders’ funds.” In my opinion, the overall rationale of going into a strategic partnership would be the further advancement of shareholder wellbeing. This could be captured by the return that they get on equity. It therefore follows that an increasing return on equity would be an attestation of the efficiency of the airline in profit generation – i.e. on the strength of the strategic decisions made by the management. Thus, if the return on equity tanks following the establishment of the alliance, a conclusion could be made to the effect that the said alliance has been ineffective.

Finding the capital necessary to support an aggressive value-enhancement strategy would be an uphill task for the airline in the current economic/financial climate. Most importantly, it would be prudent to note that the Fed recently raised interest rates. As a consequence, as Monica (2022) points out, “the central bank’s key short-term interest rate, which sat at zero at the beginning of the year, is now at a range of 3.75% to 4%.” This move was made in an apparent attempt to stem inflation. It largely means that the cost of credit has gone up – limiting the ability of enterprises (and strategic partners alike) to raise capital, i.e. as a consequence of increased interest payment. There are various options that Southwest Airlines could explore in its search for capital. These are inclusive of, but they are not limited to; loans (i.e. from commercial banks and finance companies) and equity (i.e. from investors). In as far as the first option is concerned, the airline would have to pay more in terms of interest payments. When it comes to equity financing, investors are likely to shy away from borrowing to invest in the airline (or any business for that matter) at this time. Therefore, in my opinion, the current financial climate is not favorable in as far as the acquisition of capital to pursue an aggressive value-enhancement strategy is concerned.