Balance sheets can be constructed in many ways, depending on how an airline performs and whether it owns or leases assets, invests in other businesses, and is resourced from shareholders or debt providers.
All industries have specific factors that influence the makeup of their participants' balance sheets. Whilst airlines operate in a capital intensive industry, recent experience has required most attention on balance sheets to be directed to the damage inflicted by the losses of the past four years, and whether the losses have been financed from reserves, new shareholder contributions or third party debt.
Different accounting rules applied throughout the world also have a fundamental impact on the way airlines have to structure their balance sheets. There is often a link to the political environment in which carriers operate, and any ownership stake or intervention by governments plays an important part. In countries where private enterprise is the driving force, investment capital is initially derived from either shareholders or lenders of debt. State-owned carriers receive government capital backing.
Balance sheets can have tremendous direct and indirect effects on profit and loss performance, in terms of asset cost (depreciation), asset growth (investment income) and the cost of borrowing (interest). In any examination of airline balance sheets the three main characteristics outside of working capital are tangible asset values, borrowings, and shareholders' equity.
Chart one might be termed an average airline balance sheet, and is representative of the vast majority of airlines. It shows in percentage terms the combined balance sheets of all the major North American, European and Asian carriers averaged over the last three years.
Inevitably, many individual carriers have reported balance sheets which differ widely from the average shown in this chart. However, every airline can use this as a basis for comparing its own balance sheet with the industry norm. Despite the industry's recent financial travails, there has been little change in the overall balance sheet percentages over the last three years.
For most airlines, fleet forms the major asset category and creates the major element of debt. Whilst operating leases can take many of these assets and associated debt off carriers' balance sheets, all airlines recognise that they have to strike a balance between on and off balance sheet acquisition.
Throughout the three main geographical regions around 62 per cent of total assets are fleet, property and equipment, but there are considerable differences in the level of assets held by each airline. For example in North America tangible fixed assets range from 89 per cent of total assets for Southwest to 35 per cent for Continental. Such differences have a considerable effect on profit and loss performance. Depreciation represents 5.4 per cent of Southwest's turnover and only 4.6 per cent of Continental's, and operating lease costs represent 7.7 per cent of Southwest's turnover and 11.9 per cent of Continental's.
The remaining elements of fixed assets can be split into either investments or intangibles. Here there are considerable geographical differences. In North America intangibles represent an average of 15 per cent of total assets, whilst in Europe they are only 2 per cent and in Asia 4 per cent. This is because in North America there is a market for routes and gates, which in some cases account for over 30 per cent of all assets. However, these generally have a much longer amortisation period than tangible assets, and hence the immediate effect on profit and loss can be fairly small.
In Europe and, to a greater extent, Asia there is much more emphasis on long term investments than on intangibles. This can increase the inherent risks within the balance sheet. Investments can be beneficial, but if unsuccessful they can be detrimental to both performance and balance sheets. The success of investments may not be under the direct control of the airline and may involve different areas of expertise.
In global terms, working capital (current assets less current liabilities) has remained fairly static over the past three years, but again there are considerable differences among carriers and regions. Collectively, the North American carriers have negative working capital - taken over three years, their current liabilities represent 31 per cent of total assets, outweighing current assets by 9 percentage points. However in Europe and Asia working capital is 2 per cent of net assets.
Although inventories and cash are at similar levels throughout the world, North American carriers have managed to keep their current debtors relatively low at 13 per cent of assets, whilst these are as much as 19 per cent in Europe and 18 per cent in Asia.
Within current liabilities, all the regions have very similar percentages for short-term borrowings and trade creditors, but North America's 'other creditors' represent 19 per cent of total assets, compared with only 9 per cent in Asia and 14 per cent in Europe.
Long term debt represents 41 per cent of total liabilities worldwide, but Asian carriers' long term debt is slightly higher than average at 42 per cent. Again, there are wide variances from these averages. For example Northwest's long term borrowings are 56 per cent of total liabilities whilst UAL's are 31 per cent. Air France's 57 per cent (based on the 1993 accounts) contrasts with Swissair's 31 per cent. Thai International's long term debt ratio is 53 per cent, compared with Cathay Pacific's 37 per cent.
In the area of other long term creditors and provisions, there is a dramatic difference between North America and the other two regions. As operating performance declined, many US carriers turned to the sale and leaseback as a means of cash generation, resulting in large deferred gains.
Furthermore, US carriers now have to accrue pension costs and post retirement benefits over the service lives of employees. The result is that 'other long term creditors and provisions' represent 22 per cent of total assets in North America, compared with only 13 per cent in Europe and 6 per cent in Asia.
Chart 1 also shows that as a percentage of total liabilities, shareholders' equity varies quite considerably between the three main regions. Whilst share capital itself is fairly constant at between 12 and 14 per cent, the profit and loss account and other reserves are very different in each region.
The North American market has been particularly hit, both by the operating losses incurred over the past three years and by new accounting standards that have reduced reserves considerably - the prime example being the recognition of liabilities for post retirement provisions. Hence North American profit and loss reserves are at minus 6 per cent, compared to plus 2 per cent for Europe and plus 12 per cent for Asia.
The overall shareholders' equity, or net asset figure, is also quite varied, ranging from 7 per cent for North America to 20 per cent for Europe and 27 per cent for Asia. In North America, it is apparent that despite the turnaround in profit performance in 1994, net assets have actually fallen as a percentage of total assets. This is primarily due to certain companies' restructuring efforts and significant losses at some carriers.
The most important effect that the balance sheet has on performance - or the perception of performance - relates to the level of borrowings. Several borrowings ratios are available. Chart 2 shows borrowings as a percentage of tangible fixed assets and the net debt/equity ratio.
It is difficult to identify whether borrowings are directly related to capital acquisitions or whether they are to help finance operating performance. However the ratio of borrowings to tangible fixed assets on the balance sheet at least gives an indication of the level of asset backing for borrowings.
Surprisingly it is the Asian region, particularly the Japanese market, that has the highest level of borrowings to assets, at 88 per cent. Equally surprisingly, North America has the lowest level at only 70 per cent. However, the American carriers use more off balance-sheet leasing, and this distorts the comparison.
Since the airline business is so capital-intensive, the classic debt/equity ratio is not the ideal way to show gearing. The net debt/equity ratio, which takes into account cash holdings, is more representative. Here, in Asia and to a large extent in Europe, high cash and short-term security balances together with higher levels of shareholders' equity result in much lower net debt/equity ratios than in North America.
Each airline will set its own goals for both operating performance and balance sheet ratios. For the latter, the goals may be expressed in terms of gearing ratios, the level of working capital to total assets, or the level of borrowing to assets. Whilst operating performance reflects one year's figures, the balance sheet is a much more reliable indicator of a company's long term health. As the next cycle of aircraft orders gets under way, a strong balance sheet could turn into a major competitive advantage.
Source: Airline Business
