CASE STUDY

STRATEGIC FINANCIAL PLANNING AVION AIRLINES

Submitted By Bhanu Poplani Jyoti Nayyar Komal Hotwani Komal Manglani Rakhee Singh V. Kamesh Ravi

a) Prepare a forecast profit and loss account for each of the next three years

Profit and Loss Account for year ended 31 December ($m) I II III Turnover Scheduled services 3.66 4.392 5.49 6.8625 Charter services 1.83 2.013 2.2143 2.43573 5.49 6.405 7.7043 9.29823 3.29 3.838333 4.616967 5.572163 Cost of sales 2.2 2.566667 3.087333 3.726067 Gross profit Operating costs: Staff 0.69 0.8625 1.035 1.1385 Leasing rentals 0.55 0.715 0.858 1.0296 Fuel 0.27 0.32025 0.385215 0.464912 Depreciation 0.05 0.06 0.06 0.06 Other 0.55 0.605 0.6655 0.73205 0.09 0.003917 0.083618 0.301005 Operating profit 0.02 0.000979 0.020905 0.075251 Taxation (25%) 0.07 0.002938 0.062714 0.225754 Profit after tax 0 0 0 0 Dividends 0.07 0.002938 0.062714 0.225754 Retained profits ANALYSIIS 40.07286 40.07286 40.07286 40.07286 gross profit margin 1.639344 0.06115 1.085346 3.237231 operating profit margin 1.275046 0.045863 0.81401 2.427923 net profit margin

b) Prepare a cash flow forecast for each of the next three years, assuming no time lag in tax payments
Cash Flow Statement for year ended 31 December ($m) I II 0.09 0.003917 0.083618 Operating profit 0.05 0.06 0.06 Depreciation 0.14 0.063917 0.143618 0 0.05 0.05 less: Capital expenditure 0.14 0.013917 0.093618 0 0.01 0.01 add: Net working capital 0.14 0.023917 0.103618 0.02 0.000979 0.020905 less: Taxation 0.12 0.022938 0.082714 Cash flow ANALYSIS 5.49 6.405 0.021858 0.003581 0.12 -0.02706

III 0.301005 0.06 0.361005 0.05 0.311005 0.01 0.321005 0.075251 0.245754

total turnover operating cash flow/turnover free cash flow

7.7043 0.010736 0.032714

9.29823 0.02643 0.195754

c) Identify and briefly comment on the risk factors (economic, financial, industrial, competitive, regulatory, etc.) which you consider relevant to an appraisal of the companys strategy and which would merit further assessment.

Sol. The directors Of Avion Airlines after following a strategic review of the business have prepared a three-year strategic growth plan for the company. But this is to be emphasized here that no business growth plan can ensure success unless and until due consideration has been given to external environment which pose threats as well as opportunities for the company.

Risks directly coming from external environment can be briefly classified and explained as follows:a) Economic Risk-Airlines' profitability is closely tied to economic growth and trade. If economy is prospering then there would be an increase in all other variables like income of the people who can now better afford air travel, trade of goods & services from one country to country and within the country, more business travel, urbanization, tourism, etc all positively related to airlines revenues. Thus it is high vulnerable to the state of the global economy for e.g. global slowdown or recession; Every time an economic slowdown or recession happens, flyers go for cheaper options like trains or road; there are few tourists travelling; fewer business travels planned; and airlines have to run with empty seats. As a result, they face severe liquidity crisis. Also, domestic airlines depend heavily on the state of the national economy. If there is good GDP growth and the country is witnessing rising prosperity, it will see a very bullish growth for the airlines.

b) Political Risk- This risk is related with government and its policies. Most governments rightly understand the strategic importance of airline industry at the time of crisis and wars and hence want to keep running national carriers despite the losses at times. Due to the nature of the business and the risks, many times airlines are prone to become victim of government interventions and bailouts, making the industry unique in this sense. c) Regulations: Typically airlines are highly regulated due to political, economic and safety concerns. In such regulated markets, new airlines find it difficult to come up and establish them. Also, due to restrictive practices new airlines find it difficult to obtain slots at airports. The entry barriers are low in deregulated markets, with dozens of airlines starting up from nowhere in no time. With time, the industry is seeing higher deregulation with US leading in 1978 and the Europe following up with deregulation. Deregulation increases the competition and promotes more players to enter the market.

d) Financial Risk-It is a capital intensive industry with high fixed costs. The airline industry is considered among the top of the high capital intensive industries. Airline industry also has high fixed costs as compared to revenues. This puts the industry to higher financial risk because in case it is not able to attain an economy of scale or if there is a downturn in sales, the high fixed cost cant be covered and the business becomes unprofitable. This is why there has been much higher frequency of bankruptcies in the airline industry and also a compelling merger and acquisition route to gain competitive advantage. Every time fuel costs rise, or a new tax is imposed, or a staff strike happens; or there is an inability to raise the fare proportional to the rising input costs, their profitability is hit hard. Such an unexpected hit hurts the expansion plans and the whole fiscal planning goes haywire. e) This industry can be analyzed using Michael Porters 5 forces Model where all factors and dynamics related to any Industry get covered.

This analysis is made by the identification of 5 fundamental competitive forces. These includes: Threat of Substitutes Bargaining Power of Suppliers Bargaining Power of Buyers Rivalry among the existing players Entry of Competitors

Explanation Firstly, the threat of new companies entering the industry is high and the entry barriers are low. Secondly, the bargaining power of customers is high since they are price sensitive and search for the best deals. The third force, bargaining position of suppliers, is strong since they are concentrated and this limits the control airlines have over suppliers to reduce prices and earn higher profits. The availability and threat of substitutes is another factor that can affect a companys competitive position. However, the degree of this threat depends on various factors such as time, money, convenience and personal preferences of travellers. The final force in Porters model is competitive rivalry between the companies within an industry. Cut-throat competition exists among the airlines and since there is a constant struggle for market share, the overall profit potential of this industry is low.

f) OTHER FACTORS to be considered which are also external in nature Development of new technologies Legal developments (e.g., environmental concerns and regulations)

Some opportunities for Airline- Emerging factors and trends enabling the companys
strategy The commoditization of the Airline industry Standardized and interchangeable components Emergence of reliable manufacturing service providers Recent advances in Supply Chain Management Information Technology (IT) platforms that allow the effective and efficient information exchange and coordination across the entire supply chain 3rd party logistics service providers Emerging emphasis on virtual rather than vertical company integration

d) Based on your analysis, comment on the suitability of the companys future strategy and objectives. State any other information, financial and nonfinancial which you think would assist your analysis.