Ahmed Idhuham Shareef

AIRLINE FINANCE | AVIA3001_Jan 2024

S2101339

Word Count 2489

Contents

Table Of Figures......................................................................................................................................2
Introduction..............................................................................................................................................3
Analysis Of Financial Data...................................................................................................................4
Profit and loss account.........................................................................................................................4
Balance sheet........................................................................................................................................5
Cashflow statements............................................................................................................................6
Analysis of performance health of American airline......................................................................7
Risk/Return Characteristics of Sources of Finance in Airline Operations.............................11
Analysis of Airline Capital Expansions and Decision Validity...................................................12
Analysis of cost of capital..................................................................................................................12
Existing Capital Expansions..............................................................................................................14
Evaluation of Decision-Making Process..........................................................................................14
Risk Factors and Potential Returns..................................................................................................15
Alignment with Strategic Objectives.................................................................................................15
Impact Analysis on Future Growth Post-Expansion....................................................................16
Anticipated Impact on Future Growth Trajectory............................................................................16
Contribution of Chosen Financing Structures.................................................................................16
Potential Risks and Mitigations Post-Expansion............................................................................16
Identification and Evaluation of Existing Revenue Management Techniques.......................17
Current Revenue Management Techniques....................................................................................17
Evaluation of Effectiveness...............................................................................................................17
Suggestion of Appropriate Revenue Management Method/s and Application......................18
Proposed Revenue Management Methods.....................................................................................18
Outline for Practical Application.......................................................................................................19
Conclusion.............................................................................................................................................20
Reference...............................................................................................................................................21

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Table Of Figures

Figure 1 Financial Ratio................................................................................................... 6

Figure 2 Solvency ratio.................................................................................................... 7

Figure 3 Return on equity.................................................................................................8

Figure 4 Earnings per share.............................................................................................9

Figure 5 Average cost of capital.....................................................................................11

Figure 6 Revenue management model..........................................................................18

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Introduction
The report presents an in-depth analysis of American Airlines’ financial management.
The main purpose is to examine financial statements of the airline: the Profit and Loss
Account, Balance Sheet, and Cashflow Statement for the recent year and elucidate its
current financial state. Additionally, financial rations will be calculated to determine
different aspects of American Airlines’ financial management, new issues will be
analyzed in terms of sources of finance used and their cost and impact on growth.
financing decisions of the airline will be reviewed to determine whether they have been
made in way of equity, debt, or a mix of both, and how it affects the airline’s financial
structure and long-term goals.

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Analysis Of Financial Data

Profit and loss account

Item 2021 2022

Revenue $29,882,000 $48,971,000

Cost of Revenue $16,019,000 $24,985,000

Gross Profit $13,863,000 $23,986,000
Selling, General & Admin $12,915,000 $14,787,000
Other Operating Expenses $2,007,000 $7,592,000
Operating Expenses $14,922,000 $22,379,000
Operating Income -$1,059,000 $1,607,000
Interest Expense / Income $1,800,000 $1,962,000
Other Expense / Income
Item -$311,000
2021 -$541,000
2022
Pretax Income -$2,548,000 $186,000
Cash & Equivalents $1,263,000 $1,435,000
Income Tax -$555,000 $59,000
Net Income Investments
Short-Term -$1,993,000
$12,158,000 $127,000
$8,525,000
EPS (Basic)
Receivables -$3.09
$1,505,000 $0.20
$2,138,000
EPS (Diluted)
Inventory -$3.09
$1,795,000 $0.19
$2,279,000
Free
OtherCash Flow
Current Assets $870,000
$615,000 -$226,000
$892,000
Total Current Assets $17,336,000 $15,269,000
Source:Plant
Property, work &adopted from (American
Equipment Airlines, 2019)
$37,387,000 $38,294,000
Goodwill and Intangibles $6,079,000 $6,150,000
Other Long-Term Assets $5,665,000 $5,003,000
Total Long-Term Assets $49,131,000 $49,447,000
Total Assets $66,467,000 $64,716,000
Accounts Payable $1,772,000 $2,149,000
Current Debt $3,996,000 $4,739,000
Other Current Liabilities $13,238,000 $14,608,000
Total Current Liabilities $19,006,000 $21,496,000
Long-Term Debt $42,181,000 $38,948,000
Other Long-Term Liabilities $12,620,000 $10,071,000 Balance
Total Long-Term Liabilities $54,801,000 $49,019,000 sheet
Total Liabilities $73,807,000 $70,515,000
Retained Earnings -$8,638,000 4 -$8,511,000
Shareholders' Equity -$7,340,000 -$5,799,000
Total Debt $46,177,000 $43,687,000
Source: work adopted from (American Airlines, 2019)

Cashflow statements

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 Item 2021 2022
Operating Cash $704,000 $2,173,000
Flow
Investing Cash Flow -$5,983,000 $636,000
Financing Cash $5,288,000 -$2,631,000
Flow
Net Cash Flow $9,000 $178,000
Free Cash Flow $870,000 -$226,000

Financial Ratios 2021 2022

Liquidity Ratios
Current Ratio 0.91 0.71
Quick Ratio 0.85 0.63
Solvency Ratios
Debt to Equity Ratio -6.29 -7.53
Debt to EBITDA Ratio 11.73 6.46
Performance/Earnings Ratios
Return on Equity (ROE) -0.27 -0.02
Return on Assets (ROA) -0.03 0
Earnings per Share (EPS) ($3.09) $0.20

Source: work adopted from (template Mo, 2024.)

Analysis of performance health of American airline

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Analyzing the financial ratios provides insights into the financial health and performance
of American airline The Current Ratio and Quick Ratio indicate the airline's liquidity
position, measuring its ability to meet short-term obligations. In 2021, the Current Ratio
of 0.91 suggests that the airline may face difficulty in covering its short-term liabilities
with its current assets alone. This implies potential liquidity issues, which could be
attributed to inefficient management of working capital or high debt levels. According to
Brigham and Ehrhardt (2013), a Current Ratio below 1 may indicate financial distress or
an inability to pay short-term obligations. Similarly, the Quick Ratio of 0.85 in 2021
further highlights the liquidity challenges, indicating that the airline's ability to cover
immediate liabilities excluding inventory is limited.

2021 2022

Figure 1Financial Ratio

Moving to solvency ratios, the Debt-to-Equity Ratio measures the proportion of debt
financing relative to equity. The significantly negative values in 2021 and 2022
(-6.29 and -7.53, respectively) indicate a high level of debt relative to equity, possibly

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due to substantial losses or negative equity. This suggests a high financial risk and may
raise concerns among investors and creditors regarding the airline's ability to meet its
long-term obligations. As per Ross et al. (2017), a high Debt to Equity Ratio may signal
financial distress and hinder the company's growth potential as it faces increased
financial leverage.

2022

2021

Figure 2 Solvency ratio

The Debt to EBITDA Ratio assesses the company's ability to repay its debt using its
earnings before interest, taxes, depreciation, and amortization (EBITDA). The ratio
decreased from 11.73 in 2021 to 6.46 in 2022, indicating an improvement in the airline's
capacity to service its debt obligations with its operational earnings. This may suggest
better financial stability and reduced financial risk over the period, potentially due to
cost-cutting measures or improved operational efficiency.

In terms of performance/earnings ratios, the Return on Equity (ROE) measures the

airline's profitability relative to shareholders' equity. The negative ROE values in 2021
(-0.27) and 2022 (-0.02) indicate that the airline incurred losses during both years,

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resulting in a negative return on equity. This could be attributed to various factors such
as declining revenue, high operating expenses, or impairment charges. According to
Brigham and Ehrhardt (2013), negative ROE values may indicate inefficient
management or poor utilization of shareholder funds.

2022

2021

Figure 3 Return on equity

The Return on Assets (ROA) evaluates the airline's profitability in relation to its total
assets. The negative ROA values in 2021 (-0.03) indicate that the airline generated net
losses relative to its total assets during that year. However, the ROA improved to 0.00 in
2022, suggesting a breakeven situation where the airline's net income equaled its total
assets. This improvement may indicate enhanced operational efficiency or asset
utilization over the period.

Lastly, the Earnings per Share (EPS) measures the company's profitability attributable
to each outstanding share. The negative EPS of -$3.09 in 2021 indicates a loss per

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share, while the positive EPS of $0.20 in 2022 suggests profitability. This turnaround
may signal positive prospects for investors, indicating potential growth and increased
shareholder value.

2022

2021

Figure 4 Earnings per share

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Risk/Return Characteristics of Sources of Finance in Airline
Operations

In the context of airline operations, the choice of financing sources plays a crucial role in
determining the risk and return characteristics of the capital structure (Graham &
Harvey, 2001). Debt financing involves borrowing funds from creditors with an obligation
to repay the principal amount plus interest over a specified period (Mazzola & Palmeri,
2019). While debt financing offers tax benefits and allows companies to leverage their
capital structure, it also introduces financial risk due to interest payments and the
potential for default. Airlines rely heavily on debt financing to finance aircraft purchases
and operational expenses. However, excessive debt levels can lead to liquidity issues
and increase vulnerability to economic downturns or industry-specific challenges.

Equity financing involves raising capital by issuing shares of ownership in the company
(Graham & Harvey, 2001). Unlike debt financing, equity financing does not require
repayment of principal or interest, but it dilutes existing shareholders' ownership and
may lead to dividend obligations. Equity financing provides flexibility and resilience
during periods of financial distress, as shareholders bear the risk of fluctuations in
profitability. However, issuing equity may signal undervaluation or dilution concerns,
affecting investor confidence and share price performance.

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Analysis of Airline Capital Expansions and Decision
Validity

Analysis of cost of capital

Range Selected percentage

The WACC of American Airlines Group Inc (AAL) is 6.8%.
Cost of 8.8% - 11.25%
equity 13.7% The Cost of Equity of American Airlines Group Inc (AAL) is 11.25%.

Tax rate 24.1% - 24.95% The Cost of Debt of American Airlines Group Inc (AAL) is 7.4%.
25.8%
Cost of 4.9% - 7.40%
debt 9.9%
WACC 4.9% - 6.80%
8.8%
Source: work adopted from (template Mo, 2024)

The WACC, representing the weighted average of the cost of equity and cost of debt,
hence provides a comprehensive measure of the cost of capital for AAL. With a WACC
of 6.8%, AAL faces a relatively moderate cost of capital compared to industry peers.
The cost of equity stands at 11.25%, reflecting the return required by equity investors,
while the cost of debt is 7.4%, indicating the cost of borrowing for the company.

Figure 5 Average cost of capital

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Financing Options

American airline employs a mix of internal and external financing options to meet its
capital requirements. Internal sources include retained earnings and operating cash
flows, while external sources encompass debt financing, equity issuance, and lease
financing. The company's debt-to-equity ratio of 3.39 suggests a reliance on debt
financing to support its operations. According to Modigliani and Miller's capital structure
theory, firms strive to achieve an optimal capital structure that balances the benefits of
debt financing (tax shield) with its associated costs (financial distress). By maintaining a
diversified financing mix, AAL mitigates financial risk and maximizes shareholder value.

Evaluation of Financing Strategies

The chosen financing strategies have contributed significantly to AAL's growth

trajectory. Debt financing allows the company to leverage its assets and expand its fleet,
thereby enhancing operational capacity and market reach. Equity issuance provides
AAL with additional capital for strategic investments and acquisitions, strengthening its
competitive position in the industry.

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Existing Capital Expansions

American Airlines has recently announced significant expansion plans, particularly in

trans-Atlantic routes, aiming to enhance its market presence and connectivity. These
expansions include new nonstop routes from Philadelphia to Copenhagen, Naples, and
Nice, as well as a new service from Dallas-Fort Worth to Barcelona. Additionally, the
airline is reintroducing its Chicago to Venice route and extending services to major
European destinations such as Lisbon, Madrid, and Rome.

Evaluation of Decision-Making Process

The decision-making process regarding the chosen sources of finance for these
expansions needs careful evaluation. American Airlines appears to have utilized a mix
of internal and external sources of finance, including debt financing, equity financing,
and strategic partnerships. While debt financing allows the airline to leverage its assets
and access large capital pools, it also increases financial risk due to interest payments
and potential default

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Risk Factors and Potential Returns

Each financing option comes with its own set of risk factors and potential returns. Debt
financing exposes the airline to interest rate fluctuations, debt servicing obligations, and
credit risk. However, it provides access to immediate capital without diluting ownership.
Equity financing mitigates debt-related risks but may lead to shareholder dilution and
dividend obligations.

Alignment with Strategic Objectives

The chosen financing options should align with the overall strategic objectives of the
airline, focusing on sustainable growth and value creation. Debt financing may be
suitable for financing capital-intensive projects such as aircraft purchases and
infrastructure development.

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Impact Analysis on Future Growth Post-Expansion

Anticipated Impact on Future Growth Trajectory

The capital expansions undertaken by American Airlines are expected to have a

significant impact on its future growth trajectory. By introducing new nonstop routes and
expanding services to major European destinations, the airline aims to strengthen its
market presence, enhance connectivity, and capture additional passenger demand.
These expansions could lead to increased revenue streams, market share gains, and
improved competitiveness in the trans-Atlantic market. Furthermore, the extended
service throughout the year to major European destinations signifies a commitment to
providing consistent and reliable connectivity, which could attract more passengers and
drive sustained growth.

Contribution of Chosen Financing Structures

The chosen financing structures play a crucial role in facilitating the envisioned growth
of American Airlines. Debt financing allows the airline to acquire new aircraft and invest
in infrastructure without diluting ownership control.

Potential Risks and Mitigations Post-Expansion

Despite the anticipated growth opportunities, there are potential risks that may arise
post-expansion. These include economic downturns, geopolitical instability, regulatory
changes, and competitive pressures. To mitigate these risks, American Airlines should
maintain a diversified route network, implement robust risk management strategies, and
closely monitor market trends. Additionally, effective cost management, operational
efficiency improvements, and customer-focused initiatives can enhance the airline's
resilience and mitigate adverse impacts on growth.

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Identification and Evaluation of Existing Revenue
Management Techniques

Current Revenue Management Techniques

American Airlines employs several revenue management techniques to optimize its

revenue generation. These include dynamic pricing, inventory management,
overbooking, and ancillary revenue strategies (Smith, 2019).

Dynamic pricing involves adjusting ticket prices based on demand fluctuations, time
until departure, and competitor pricing (Talluri & Van Ryzin, 2004). Inventory
management entails allocating available seats across different booking classes to
maximize revenue while considering factors such as fare rules and seat availability
(Weatherford & Bodily, 1992). Overbooking allows the airline to sell more tickets than
available seats to mitigate revenue loss due to no-shows and cancellations (Belobaba,
1989). Ancillary revenue strategies involve offering additional services or products, such
as seat upgrades and baggage fees, to generate supplemental revenue (Ito & Lee,
2007).

Evaluation of Effectiveness

These existing revenue management techniques have demonstrated effectiveness in

maximizing revenue for American Airlines. They are adaptable to changing market
conditions, allowing the airline to adjust pricing and inventory allocation dynamically
(Bitran & Caldentey, 2003). Moreover, these techniques leverage advanced data
analytics and forecasting models to enhance accuracy in demand prediction and pricing
decisions (Talluri & Van Ryzin, 2004). Overall, they align with industry best practices
and contribute to the airline's revenue optimization efforts.

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 Suggestion of Appropriate Revenue Management Method/s
and Application

Proposed Revenue Management Methods

Based on the evaluation of existing techniques, the following revenue management

methods are suggested for American Airlines:

Demand forecasting: Implement advanced demand forecasting models to predict

future demand patterns accurately (Weatherford & Bodily, 1992). This will enable the
airline to optimize pricing and inventory allocation strategies proactively.

Personalized pricing: Utilize data analytics and customer segmentation techniques to

offer personalized pricing and promotions tailored to individual preferences and booking
behavior (Ito & Lee, 2007).

Dynamic bundling: Introduce dynamic bundling strategies to offer customized

packages combining airfare with ancillary products and services, maximizing revenue
and enhancing customer value perception (Bitran & Caldentey, 2003).

Real-time optimization: Implement real-time optimization algorithms to adjust pricing

and inventory allocation dynamically in response to changing market conditions,
competitor actions, and customer behavior (Talluri & Van Ryzin, 2004).

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Outline for Practical Application

American Airlines should invest in advanced data analytics and revenue management
systems, train employees on data-driven decision-making, and regularly evaluate and
adjust strategies to align with market dynamics and business objectives. Additionally
Foster a culture of innovation and continuous improvement, encouraging
experimentation and learning to drive revenue management excellence and sustainable
growth (Bitran & Caldentey, 2003; Talluri & Van Ryzin, 2004).

Figure 6 Revenue management model

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Conclusion

In conclusion, this analysis American airline's financial operations underscores the

significance of informed decision-making for sustainable growth. By scrutinizing sources
of finance, capital expansions, future growth prospects, and revenue management
techniques, critical insights were gleaned. Evaluating risk-return dynamics in financing,
aligning strategic objectives with expansion decisions, and implementing effective
revenue management strategies that are paramount. Through this holistic approach,
airlines can navigate challenges, capitalize on opportunities, and position themselves
for long-term success in the competitive aviation landscape.

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