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Financial Leverage

First of all, the return on asset implies a company’s ability to use its assets to create profits. An upsurge of the ratio of course indicates CSA is using its assets well. However, from Appendix 1, the ratio tends to go down by 0. 42% and it is mainly because of a noticeable cut of its profit margin within 2001. In reality, the profit margin of CSA decreased by 1. 43% which represents the efficiency of CSA has gone downhill during the period. Moreover, it is clear to conclude that the cost control of CSA has been weakening in consistent with producing less profit from its sales.

Subsequently, CSA has not converted its resources successfully when comparing with 2000. However, it seems that there was no choice for CSA to lessen its profit margin since the capacity of airline industry is almost full, the phenomenon of surplus and vigorous competition is presenting as a step-down transformer. Apart from the profit margin, it is essential to explore the asset turnover since it is one of the pieces making up the return on asset.

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This ratio is in connection with the company’s capability to generate sales from its investment in assets.

During the year of 2001, the asset turnover of CSA improved by 0. 06. This minor growth vastly reduced the percentage loss in ROCE that also signified the superior management in CSA’s effectiveness. From the above analysis, it is evident that the sales of CSA increased and hence it has a higher asset turnover when weighing against the previous financial phase.

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Finally, the financial leverage (FL) is concerning the capital structure; it is the use of debt to increase a company’s ROCE. From Appendix 1, it is clear that the net debt to asset has increased to 1.

32 in 2001, so it means that the company has to pay more interests for its debts. Besides, when the debts of CSA increased, its total assets also went up as well as the financial leverage. If truth to be told, the financial leverage magnification factor favored the ROCE. In the advent of a positive value in the return on assets, the financial leverage magnifies the amount of ROCE. The following calculation shows the difference occur while using the financial leverage in 2000 and 2001.

From the above example, it is clear that when the financial leverage increases, the return on capital employed increases too, providing that the return on asset is positive. Furthermore, the financial risk will increase the risk of the shareholders; accordingly, the decreasing trend in ROCE will have a bad effect in the shareholder’s point of view. It is because of the financial leverage just saved CSA from suffering of a greater decrease in ROCE instead of boosting it up. Dividend is invariably the most important concern of the shareholders.

They are the one who finance the company and would like to attain benefits through their investments. Also they realized that CSA is a high-risk company when they first invested, as its operation and financial leverages are high. Incontrovertibly, they would like to earn more from the long-run profits and stock value and of course the investors will expect a higher return from a high-risk company – CSA. Recently, CSA is on its growing stage, therefore the decision of dividend payout at the moment will not cause any harmful effects, such as no dividend will be paid this year.

In long, CSA must ensure a sufficient level of profit to for the payment of dividends or for reinvestment to heighten a greater stock value. Analysis of Liquidity As stated by the Consolidated Balance Sheet in Appendix 3 and 4, the current assets decreased to RMB 4,378 million in 2001 and the fundamental reason was mainly due to the significant drop of cash and cash equivalents from RMB 4,197 million in 2000 to RMB 2,817 million in 2001. On the other hand, the quantity of bank and other loans increased from RMB 783 million to RMB 2,177 million radically that led to an incline of RMB 969 million and reached another peak of RMB 8,074 million.

The enormous amount of money used in 2001 is attributable to the acquisition of the non – current assets through paying the lease and equipment deposit along with investments in jointly controlled entity and associated company. CSA has spent additional RMB 1,827 million and RMB 174 million on the above issues respectively. Obviously, the added amount of liabilities and the reduced amount of cash were based on the delivery of two new Boeing 747-400 freighters, the full year effect of five Boeing 737-300 / 37K aircraft wet leased from Zhongyuan Airline plus the investment in associated company and jointly controlled entity.

Moreover, the current liabilities as at the end of 2001 inclined to RMB 2,177 million since there are significant amount of earlier borrowings in 1998 come to the due date, which was the time of the Asian Economic Crisis. Resulting from the huge outflow of cash as well as a great pressure from the previous loans, the current ratios of CSA fell down considerably. From the ratios calculated in the previous task, there is no doubt to reckon that the liquidity of CSA is on its edge. The current assets ratio in 2000 was already in a threatening position with the value of 0.

83, meanwhile the ratio further diminished to 0. 54 in 2001. It is indisputable that the current ratio of a company should at least equal to one. If this were not so, and creditors pressed for payment, some fixed assets would have to be sold, grinding down productive capacity as long as loan could be negotiated. In this circumstance, creditors tend to impose the debt covenants that are limitations for CSA to borrow extra money since they would like to reduce the faced risks. In addition to the current asset ratio, the acid test provides a more transparent insight to CSA’s liquidity.

Stock is an asset, which is hard to transfer to cash and it takes time to do so. After reducing the stocks from the current asset, the ability of CSA to repay for its debt arrived to a new bottom point that is 0. 48. Although it is relatively better than the current asset ratio since the percentage amendment is comparatively lower, it still suggests that the position of CSA to meet its current liability obligations is lower since the ratio decreases substantially over time. In details, it is reasonable to investigate the cash flow of CSA with the year and identify how did it use its cash for and eventually affected its liquidity.

Apparently, the net cash used in the investing activities vastly rose up according to Appendix 5 and from Appendix 1, the ratio of investment cash flow to assets climbed up by 9. 07 %. As I have mentioned before, most of the money has been used in the payment of lease and equipment deposits. Unquestionably, the growth in assets will assist further expansion in sales since the production capacity multiply correspondingly, and hence additional profits may be created. However, it is vital to the management team that the demand of aviation fluctuates all the time and as the industry is dynamic, the risks accompanied increased too.

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Financial Leverage. (2020, Jun 02). Retrieved from http://studymoose.com/financial-leverage-essay

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