Abstract
The report covers liquidity ratios for Etihad Airways for the fiscal period 2014. Traditional ratios, such as current ratio and quick ratio, show that Etihad can meet its short-term financial commitments when they are due. Conversely, cash flow liquidity ratio shows that the company can only pay off about 50% of its short-term debts when they are due. Given this scenario, researchers have preferred cash flow ratios because they present information on financial liquidity position that is more reliable. As such, Etihad Airways cannot meet its short-term financial commitments and there is no evidence that it pays dividends. Hence, it is not suitable for potential investors.
Introduction
This financial ratio analysis for Etihad Airways PJSC covers fiscal year 2014. It presents three liquidity ratios, shows whether the company can meet its short-term financial commitments, and provides the decision to invest in the company or not. These ratios are obtained from different financial statements of the company and acts as performance measures (Illinois Department of Commerce and Economic Opportunity, n.d; Jamil & Mohamed, 2011).
The Three Liquidity Ratios
Current Ratio
Current Ratio = Current Assets / Current Liabilities
3,477/3,435 = 1.012
According to this ratio, Etihad has a perfect ratio of 1 and, therefore, it can meet its short-term obligations as they fall due on a particular time.
This liquidity ratio is obtained by comparing Etihad’s total current assets against its total current liabilities. It will show whether Etihad can meet its short-term debt obligations. This ratio generally provides a quick means to assess financial health of Etihad. Higher ratio is preferred because it reflects high capabilities of paying off debts. That is, a company has a significant fraction of asset values compared to its total current liabilities.
A ratio below 1 shows that a company has significantly greater liabilities relative to its assets, and it shows that the company may not be able to pay its debt if they mature at a given period. While a ratio below 1 indicates that a company may be in a bad fiscal state, the ratio does not point toward bankruptcy. Firms with liquidity issues can use multiple methods to access financing. However, this is only viable if a firm demonstrates realistic expectations of its potential earnings against which it may rely on to borrow. For instance, a reasonable short-term debt can easily be managed with significant returns from short-term investments or projects once the debt is due. All the same, Etihad has a good ratio of 1, at least for the moment, and this is a good sign of fiscal health.
Quick or Acid Test Ratio
Quick ratio = (current assets – inventories) / current liabilities
(3,477 – 73) / 3,435 = 0.991
Etihad Airways has a quick ratio of 1. Hence, it can meet its short-term obligations when they fall due. However, when this ratio falls below 1, then it is a cause for concern about liquid assets of the company and its abilities to meet current liabilities. Whenever the acid test ratio significantly becomes low relative to the current ratio, then it shows that the company’s current assets are highly leveraged by the inventory.
It is advisable for users of financial statements to consider other items, such inventory turnover when the ratio is below one. Besides, it is imperative to recognize that the acid test ratio may differ based on the industry. In this case, an analyst should also assess ratios of other airline companies in the region, such as Emirates Airlines. Hence, the ratio assessment and comparison would be meaningful for the industry peers.
For most industries, the quick ratio above 1 is generally preferred. Then again, an extremely high quick ratio could indicate poor management of the company’s cash. That is, the company has an idle cash. Such cash should be reinvested to generate more revenues, returned to investors or otherwise invested in other useful operations of the company. It is imperative to recognize that some companies may generate more cash and consequently have higher quick ratios above 5. While these companies have cash, obviously, they do not pay dividends to shareholders. Investors therefore should not consider such companies for investment because of poor returns.
Cash Flow Liquidity Ratio
Cash and Cash Equivalents + Marketable Securities + Cash Flow from Operations / Total Current Liabilities
(718 + 923 + 117) / 3,435 = 0.51
Etihad Airways has a cash flow liquidity ratio of 0.51. The ratio is below 1. In short, Etihad has generated significantly less cash during the fiscal year 2014 relative to the amount of cash required to cover for its short-term debts. This ratio implies that Etihad generated cash that could only pay off about 51% of its short-term debts when they fall due. In this regard, the ratio shows that Etihad Airways may require more capital from its investors. Typically, investors and creditors would opt for a company with significantly higher cash flow ratio.
The cash flow is imperative for assessing a firm’s liquidity on a short-term basis (Bhandari & Iyer, 2013). Cash flow ratio is believed to present the actual financial health of the company compared to income simply because cash is the most preferred means of paying off debts.
It is imperative to observe, however, that a low cash flow ratio below 1 is not necessarily a poor sign of cash generation. If cash is tied in some investments that are most likely to generate cash, then this is a good sign.
Etihad Liquidity Financial Ratios and Short-term Financial Commitments
Both current ratio and quick ratio show that Etihad Airways can meet its short-term financial commitments. Cash flow liquidity ratio, however, shows that Etihad Airways can only pay off about 50 percent of its short-term debts when they fall due.
It is concluded that Etihad Airways cannot meet its short—term financial commitments.
Current and quick ratios are considered as traditional ratios (Mills & Yamamura, 1998). Conversely, cash flow ratios are of interest to lenders and investors because they offer more information on how a firm can meet its short-term and long-term debt obligations relative to traditional ratios obtained from the balance sheet capital ratios, including the quick ratio and current ratio (Mills & Yamamura, 1998). When the lender assesses the risk involved by lending to Etihad Airways, the greatest concern is whether the Airline would be able to repay the loan with related interest on the due date. Traditional working capital ratios have only shown much cash Etihad Airways had on a given day in the fiscal year 2014.
Conversely, cash flow ratios show how much cash Etihad Airways generated over time and related that to its short-term commitments, providing a clear picture of what resources it will gather to cover its debts.
On this note, researchers have clearly demonstrated that the traditional ratio and cash flow ratio generally differ (Atieh, 2014; Mills & Yamamura, 1998; Ryu & Jang, 2004). The traditional ratio uses values from the balance sheet while the latter derives its value from cash flow statements. Thus, they show that a conclusion of liquidity based solely on traditional ratios could be misleading (Atieh, 2014). Hence, it is imperative to compare ratios from both traditional ratios and cash flow ratios before drawing any conclusions concerning Etihad Airways financial liquidity position (Atieh, 2014). This situation is not unique to Etihad because studies established similar trends in the hotel and casino business (Ryu & Jang, 2004).
Willingness to Invest in the Company
It is not advisable to invest in Etihad Airways because it can hardly meet its short-term commitments. At the same time, there is no evidence in the financial statement of 2014 that the company pays out dividend to shareholders. Potential investors should therefore hold on or look for attractive investment options.
Conclusion
Ratios are the quickest way to assess financial health of a company. Liquidity ratios, such as quick ratio, current ratios and cash flow liquidity ratio, investigated here demonstrate different results. The two traditional ratios show that Etihad Airways can meet its short-term obligations. Conversely, cash flow liquidity ratio has demonstrated that the company cannot meet those obligations. Researchers note that both cash flow ratios and traditional ratios should be used to determine liquidity of a company. Overall, they promote cash flow ratios because they offer more information. It is not advisable to invest in the company because of its liquidity issues and there is no evidence that it pays dividends to shareholders.
References
Atieh, S. H. (2014). Liquidity Analysis Using Cash Flow Ratios as Compared to Traditional Ratios in the Pharmaceutical Sector in Jordan. International Journal of Financial Research, 5(3), 146-158. Web.
Bhandari, S. B., & Iyer, R. (2013). Predicting business failure using cash flow statement based measures. Managerial Finance 39(7), 667-676.
Illinois Department of Commerce and Economic Opportunity. (n.d). A Simple Guide to Your Company’s Financial Statements. Springfield, Illinois: Small Business Development Center.
Jamil, C. M., & Mohamed, R. (2011). Performance Measurement System (PMS) In Small Medium Enterprises (SMES): A Practical Modified Framework. World Journal of Social Sciences, 1(3), 200-212.
Mills, J. R., & Yamamura, J. H. (1998). The Power of Cash Flow Ratios. Journal of Accountancy. Web.
Ryu, K., & Jang, S. (2004). Performance Measurement through Cash Flow Ratios and Traditional Ratios: A Comparison of Commercial and Casino Hotel Companies. Journal of Hospitality Financial Management, 12(1), 15-25.