Southwest Airlines Company Ratio Analysis

Southwest Airlines wishes to start a service to a new destination which is a significant capital budgeting project for the firm. The project will have an impact on various categories of financial ratios key among them profitability, liquidity, and gearing. The new service will affect the profit margin, current ratio and the debt to equity ratio. It may take some time for the new market to become profitable hence this will affect the profit margin, consequently, the margin could decrease. Additional investments in current assets and accruing liabilities may affect the firm's liquidity. If the firm decides to finance the new destination through new debt instead of equity, then its leverage will increase thereby impacting on the debt to equity ratio.

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In the year 2017, Southwest Airlines generated a profit margin of 16% which shows a slight improvement from 11% recorded in 2016 (see appendix 1). The increase signifies an improvement in the firm's profitability from $2.244 billion in 2016 to $3.488 billion in 2017 (Yahoo Finance, 2018). The profit margin of 16% was significantly higher compared to 8.67% and 4.55% for its competitors Delta Airlines and American Group Airlines (Yahoo Finance, 2018). The current ratio evaluates the capacity of a business to meet its near-term obligations using its current assets. Southwest Airlines has slightly improved its current ratio from 0.66 to 0.69 over the two years which indicates an improvement in liquidity though it was below the ideal benchmark of one. In 2017, the corporation had a higher current ratio of 0.69 compared to 0.42 for Delta Airlines and 0.61 for American Airlines hence it was more liquid. Debt to equity ratio is a measure of the balance between long-term debt and the shareholders' equity. The debt to equity ratio of the firm decreased from 0.4 in 2016 to 0.35 in 2017. Therefore, Southwest Airlines is less risky than its competitors Delta Airlines and American Airlines which recorded debt to equity ratios of 0.47 and 6.38 respectively in 2017. The higher numbers imply that the competitors had much more significant portions of debt in their capital structure compared to Southwest Airlines.

I have selected American Airlines and Delta Airlines since they offer the same services and operates the same scheduled routes with Southwest Airlines. According to the Southwest Airlines Annual Report (2017), these firms compete based on the same factors such as pricing, cost structure, operational reliability, and amenities.

If the firm's management decides to finance the operations of the new market through additional debt, then the debt to equity ratio will increase. However, with adequate operations costs will reduce hence improving profitability. The extra cash generated may be utilized to pay off or reduce the existing liabilities thus enhancing the debt to equity and current ratios. Suitable marketing strategies will lead to an increase in sales, therefore, improving the firm's profit margin.

References

Yahoo Finance. (2018). American Airlines Group Inc. financials. Retrieved from https://finance.yahoo.com/quote/AAL/key-statistics?p=AAL

Yahoo Finance. (2018). Delta Airlines financials. Retrieved from https://finance.yahoo.com/quote/DAL/key-statistics?p=DAL

Yahoo Finance. (2018). Southwest Airlines Co. financials. Retrieved from https://finance.yahoo.com/quote/LUV/financials?p=LUV

Southwest Airlines. (2017). Southwest Airlines.2017 annual report. Retrieved from http://investors.southwest.com/~/media/Files/S/Southwest-IR/Bookmarked%20Annual%20no%20blanks.pdf