Sources of finance for British Airways
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Published: Thu, 27 Apr 2017
British Airways Plc is an international schedule airline. The main activities of British Airways Plc are the operation of international and domestic scheduled air services for the carriage of the passengers, freight and mail and the provision of ancillary services. The Company’s principal place of business is London with presence at Heathrow, Gatwick and London City airport. The Company also operates a worldwide air cargo services. The Company flies more than 300 destinations worldwide. The Company supports the United Kingdom economy by providing vital leisure travel for holidays and family reunion.
Sources of Finance:
Lack of cash is one of the biggest problems facing a business. Business would not be able to survive without cash. There are various sources of finance to activate the company. Different sources of finance apply to different circumstances. Funds are available from internal as well as external sources of finance. But each source has some advantages and disadvantages.
Internal sources of finance usually have the advantage that they are flexible. They may also be obtained quickly and need not require the compliance of the other parties.
According to Gitman (2008)”The accumulated net income that has been retained for reinvestment in the business rather than paid out in the dividends to stock holders.”
The amount of profit which left in the business after paying tax and distribution to stock holders that is retained profit. This money can be used for the expansion or investment of the business.
When a company makes profit it does not spend it, it keeps it to use for company development or the owner can think to keep it for any future difficulties. BA had been making lots of profit for long time, it did not spend all the profits. BA has lots of Retained profit which it can use now as the company is not doing well at present.
Sale of New Shares:
New shares or ordinary shares form the backbone of the financial structure of a business. When BA needs fund then BA can sell their shares to the public. To sell new shares BA needs the services of agency, normally Merchant Bank. There are some problems with this source of finance – like the existing shareholders might object to sale the shares to the outsiders.
According to Atrill (2008) “New stock (share) issue offered to existing stockholders (shareholders) in promotion to their current stock/shareholding, for a specific period and at a specified (usually discounted) price.”
Rather than taking debt, BA can ask its existing shareholders to buy some new shares to provide extra capital.
This type of issue gives the shareholders the right to purchase new shares at a discount price to the market and give the existing shareholders the opportunity to increase their stock. When the companies are in trouble, especially when the companies are unable to borrow more money they usually use right issue to pay the debt.
But there are some problems of right issue, such as -the value of share will be deducted so that the numbers of share can be increased. Secondly it is not certain that shareholders always getting a bargain as there is no opportunity to compare the market value.
Leasing is like renting a piece of equipment or machinery. The business pays a regular amount for a period of time, but the item belongs to the leasing company.
Leasing is cheaper than buying equipment but it is good for the short term. It also useful when the technology changes very quickly, so that it can be regularly updated and replaced. It also makes the cash flow management easy because the payment is done regularly.
There are some disadvantages of leasing; it becomes very expensive for the long term because the leasing company charge fees which makes the total cost of the company greater than the original cost.
Business hires machineries or equipments for a period of time for which the company makes some fixed regular payments. When the fixed payment is finished the company becomes the owner of that equipment or machinery. The difference between the hire purchase and leasing is that in case of hire purchase after finishing the fixed payment the company becomes the owner of the equipment but in case of leasing the company never becomes owner, Burton and Brown (2009).
Preference shares offer investor a lower risk than ordinary shares, provided there are sufficient profit available. Preference shares normally give a fixed rate of dividend each year and when there is any payment of dividend then the preference shareholders will be paid first.
The most appropriate source of finance to fund the expansion and other operating activities of British Airways Plc depends on whether it is for short-term or long-term, and also on the cost and speed of arranging the finance. The internal sources of finance can be obtained quickly – particularly from working capital source- and need not require the compliance of other parties, so for example, if British Airways needs to arrange fund within sort time then internal sources are appropriate, if the company needs funds for short – term then the bank overdraft or loans are appropriate. However it is advisable that the company should always think about a mixture of sources.
One of the most important long-term decisions for any business relates to investment. According to Ennew and Waite (2007) “Investment is the purchase or creation of assets with the objective of making gain in the future.”
Typically investment involves using financial sources to purchase machine/building or other assets for the purpose of getting returns over a period of time.
The six stages of investment appraisal:
British Airways need to find new opportunities for investment, generating ideas for new business development to survive and to grow the company wider.
Screening for strategic fit:
A lot of project could create value for a company but not for other. For selecting a particular project British airways must have to be aware of whether they need more capital and whether they have experience and skill for service
Analysing in detail the implication of accepting the project:
British Airways need to concern about the incriminated cash flows that could be generated by the project. For this process they need to consider the capital assets, cost, time, scale of operation and so on.
For this process British airways need to calculate various number of appraisal from the cash flows forecasts.
Accept/ reject decision:
Sometimes British airways take decision in the first stage then evaluate the project, otherwise after evaluation they decide whether to accept or reject the project.
Ex-post decision review:
British airways should draw lessons from the project that goes wrong – and the project that goes right.
Common appraisal measures which are used in British airways are as follows:
Payback Period (PP)
Average Rate of Return (ARR)
Net Present Value (NPV)
Internal Rate of Return (IRR)
According to Gitman (2008) “Literally Payback is the amount of time required for the cash inflows from a capital investment in a project to equal the cash outflows.”
Payback periods are commonly used to estimate proposed investment and often used as an initial screening method. Payback period = Initial payment / annual cash flow So, if £500 m is invested with the aim of earning £700 m per year (net cash earnings), the payback period is calculated thus: P = £500 m = 5years
The shorter the payback period the better the investment. If there are two or more competing projects that are both shorter than the maximum payback period requirement then the decision maker should select the project with shorter payback period. Because using that project managers can recoup their cost within short time. Payback is perhaps the simplest method of looking at one or more investment project or ideas. Payback is popular because it is simply understandable and easy to calculate Payback uses cash flow not the profit and therefore it is difficult to manipulate.
Average Rate of Return (ARR):
According to Glautier (2001) “The rate of earning obtained on the average capital investment over the life of a capital project; computed as average annual profits divided by average investment; not based on case flow.”
The average rate of return expresses the profits arising from a project as a percentage of the initial capital cost. The ARR method takes the average accounting profit; the investment will generate and expresses it as a percentage of the average investment met over the life of the process.
Average annual profit
ARR = Ã- 100
For example, British airways invested £25m and expected to generate total revenues of £50m for 5 years over the project. So
£50m ÷ 5
ARR = Ã- 100
ARR = 40%
Like payback method, ARR is also simple to understand and easy to calculate. There is also a link with some accounting measure that is commonly used. The Average Rate of Return is similar to the return of capital Employed in its construction; this may make the ARR easier for business planners to understand. The ARR is expressed in percentage terms and this also the manager easy to use.
The ARR doesn’t take into account of the project duration or the timing of cash flows over the course of the project. The concept of profit is very subjective and there is variation in accounting practice that’s why ARR calculation would likely be different for identical project.
The Internal Rate of Return (IRR):
According to Shapiro (2003) “The IRR is the annual percentage return achieved by a project, at which the sum of discounted cash flows over the life of the project is equal to the sum of the capital invested.” Another way is that the IRR is the rate of interest that reduces the NPV to zero.
Net Present Value (NPV):
According to Dunn and Kilgour (2009) “The Net Present Value (NPV) is an investment (project) is the difference between the sums of the discounted cash flows which are expected from the investment and the amount which is initially invested.” It is the first traditional valuation method used in the Discounted Cash Flow (DCF) measurement methodology. NPV is calculated by using a discount rate equivalent to the interest which would be received, or interest to be paid by the firm.
Here, Rt = net cash Flow
i = interest rate
t = time
NPV technique is mostly used by the managers because it is very easy to calculate. When the NPV is positive it means the project is worthwhile. So if there are more than one appraisal then the project should be selected which produces the highest NPV. But the biggest problem for NPV is that a project may have more than one IRR, if the company adopt IRR similar project and invest based on previous IRR which may not be appropriate.
Performance analysis for British Airways:
After completing the proposed investment project it is the time to evaluate the performance analysis of British Airways:
According to Norton and Kaplan (2009) “The balance scorecard is a strategic and management system that is used extensively in business industry, government and non-profit organizations worldwide to align business activities to the vision and strategy of the organization, improve internal and external communications and monitor or organize performance against strategic goals.”
The balanced scorecard has evolved from its early use as simple performance measurement framework to a full strategic planning and management system.
Financial Ratio analysis:
British Airways produces annual and monthly financial statements to comply with record keeping requirement of the company.
According to Gitman (2008) “Financial ratio analysis and balanced sheet analysis ids incorporate in the financial scorecard tool, to provide a unique picture of a company’s financial position”
The Profitability ratio is used to check that the company is generating an acceptable return for its owners.
Gross profit margin:
Gross profit represents the difference between sales value and the cost of the sales. Therefore it is a measure of profitability in buying and selling goods.
Net profit margin:
The net profit ratio represents the profit from trading operation before any cost of servicing long term finances are taken into account.
ROCE is considered to be a primary measure of profitability. It compares inputs (capital invested) with outputs (profit).
Profitability of British Airways is growing every year that means the company is doing well and the profitability is better than Rayne Air in 2008.
It is important for a business to be profitable, but profit is not sufficient on its own to guarantee survival. There must be sufficient liquid assets available to
be forced into liquidation.
The current ratio is a measure of company’s ability to meet its short time debts. This is important because the company could run out of cash and can be forced into liquidation even if it was making profit.
Quick Assets Ratio (Acid Test Ratio):
This ratio concentrates on those current assets which are immediately available to pay the creditors as and when they fall due.
Total current assets are more than liabilities for British Airways in every year that means company doing well in compare to Rayne Air British Air is in better position.
The efficiency Ratio gives an insight into the effectiveness of the company’s management of the components of working capital.
In year 2006 British Airways received payment within 30 days but the company made payment within 34 days, which is good for the company because the company made payment 4 days after receiving payment, other year’s also same situation. This is also comparatively better than Rayne Air.
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