The current ratio is a widely used metric in financial analysis; it compares current assets with the current liability to assess if the business has sufficient liquid funds.
If current assets of the business exceed current liability, the liquidity is assessed to be in good shape and vice versa. This article aims to study the current ratio of the industry in connection with related fluctuation and data analytics.
Various factors impact the liquidity numbers of the business that include business model, industry practice, business-specific decisions, and the liability structure of the business.
Efficient use of the assets and better financial planning has proved to be a milestone in managing liquidity. However, that might not be the case with all businesses. Let’s analyze the main aspects of the current ratio with regard to the global airline industry.
Global airline industry with perspective to liquidity/current ratio
The global airline industry is subject to seasonal variation and changes in business and economic conditions worldwide. Let’s glance over the current ratios of the major airlines around the globe.
|Country||Current assets||Current liability||Current ratio||Inventory||Quick ratio|
|American airlines||United States||11,095||16,569||0.670||1,614||0.572|
|Delta airline||United States||17,404||15,927||1.093||377||1.069|
|United airlines||United States||14,800||12,729||1.163||932||1.089|
|Air France KLM||France||9,895||11,778||0.840||543||0.794|
|China Southern airline||China||38,985||95,681||0.407||1,760||0.389|
|All Nippon airways||Japan||571,162||530,546||1.077||67,312||0.950|
It’s important to note that the benchmark in the case of the current ratio is 1; this implies that the business has sufficient liquid resources to pay off the liability that falls due in twelve months period.
However, the calculated average current ratios with the figures obtained from annual reports of the respective companies suggest that industry average of 0.786. It means the industry is not overall liquid.
It’s equally important to note that the airlines do not have significant inventory. The inventory is limited to the spare parts and the stored gasoline.
That’s why inventory does not contain more than 14% of the current assets in the entire list, and the average inventory of the total current assets amounts to 7.43% that’s in line with the expectation of the service sector. In simple words, the difference between the current ratio and quick ratio is marginal due to the lower level of inventory required in the airline industry.
Overall, the industry average for the current ratio is below-1. So, we need to analyze further why lower liquidity is the case with an overall industry. We’ll consider different factors like the business model of the industry, operational aspects, industry practice, and the components of the formula to calculate the current ratio.
The current ratio and business model of industry
The liquidity/current ratio level varies from industry to industry on account of changes in the business model. The business model of the airline industry supports a lower current ratio because of the following reasons.
- Higher current liabilities – advance from customers/prepayments are a major portion of the current liability structure. In addition to this, air traffic liability, payable under liability program, and operating lease liabilities are normally observed in the business’s financial statement.
- Lower current assets – Inventory is limited to the spare parts of the aircraft, and the equipment itself is classified as a non-current asset in the company’s balance sheet.
The airline industry’s business model seems to be more dependent on the quality of services and customer satisfaction with proper maintenance and managing competence.
Analysis of formula components to analyze the current ratio
There are two main components of the current ratio – current assets and current liability. The head of current assets includes items like fuel inventory, spare parts, and other related to normal trade like debtors, short-term investments, prepaid expenses, and other assets.
The common line item at the side of liability is lease obligation; it’s a common practice of industry to acquire aircraft and operate on new routes. However, COVID-19 has adversely affected the feasibility of newly added aircraft, and the industry is currently facing issues about profitability and liquidity.
Further, the industry is centered on controlling the liquidity with certain actions like,
- Reducing/eliminating the planned capital expenditures.
- Raising finance via loan.
- Suspending share repurchase and the dividends.
- Postponing the payments for the voluntary retirement funds.
The recent pandemic of COVID-19 adversely affected the airline industry in terms of profitability and liquidity. The pandemic is expected to cost the global aviation industry $201 billion from 2020-2022. However, the industry is expected to gain profit back in 2023.
From per accounting point of view, loss in the operations leads to draining cash from the business, which might be so severe that it leads to business liquidation. So, the industry has adopted certain safeguards to remain protected in terms of liquidity covenants and other aspects.
Aspects of improving liquidity structure of airline industry
The airline needs to actively take action and stop the drain of the cash resources to ensure survival. Following actions are relevant in the case of the airline industry to manage/enhance their liquidity position.
- Consider sale and leaseback of the aircraft. The option may lead to an increase in gearing and a reduction in profit. Still, it can be a good idea to raise the finance in such an unprecedented time.
- Execute negotiation of the loan contracts with the lenders. Special concessions can be requested on account of the air industry ecosystem.
- Prioritize the payments for the key suppliers.
- Consider reducing the human capital cost. An executive cut in the compensation can be a good idea.
- Look for the Government subsidy to assess if there is some opportunity to avail a loan on relaxed terms.
The current ratio is an important metric to assess the liquidity structure of the business. It helps to assess if sufficient cash is available to meet the current liabilities that fall due.
The current ratio equal to one is considered the least benchmark as it helps to ensure sufficient cash is available to meet liabilities that fall due. Recent figures of the airline industry suggest that the average current ratio is 0.848, which seems due to the airline industry’s business model. Similarly, there is a marginal difference in the current and quick ratio as maintenance inventory required is limited for effective operations.
The business model of the airline industry supports lower assets in terms of spare parts and fuel. While, current liabilities are usually higher due to lease obligations, booking and recording of the deferred income, and other payables.
Further, the pandemic of COVID-19 has severely affected the liquidity and profitability of the airline industry. Restricted air traveling and increased procedural formalities have severely affected the demand for airlines services.
However, the companies can take certain actions to stop the drain of the cash from a business. These actions include but are not limited to reducing capital expenditure, cutting executive costs, raising subsidized finance, and negotiating repayment terms with the lenders.
Frequently asked questions
Why airline industry has a lower current ratio?
The airline industry has a lower current ratio due to its business model. As aircraft incur significant costs, most airlines finance purchase via lease, and a certain part of the lease obligation is classified as a current liability. Further, collection on account of advanced booking is classified as a liability. Hence, the nature of the business supports a higher proportion of the current liability, and this leads to a lower value of the current ratio.
What’s an ideal current ratio for the airline industry?
Normally, a current ratio above one is considered to be good. However, it’s judgmental, and several factors need to be analyzed to conclude the current ratio’s adequacy. Overall, the current ratio equal to one can be considered good with perspective to the airline industry due to its business model.
What’s the impact of COVID-19 on the airline industry?
Covid-19 had a significant impact on the profitability and liquidity of the airline industry. It was one of the highest affected industries due to travel restrictions and the closure of tourism. As per a reliable estimate, the industry has to face a loss of $201 billion from 2020-2022.