Southwest Airlines’ Strategic Corporate Finance Coursework

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Table of Contents

Summary
Ratio Analysis
Income statement for Southwest Airlines
Southwest Airlines Corporation Balance Sheet
References

Summary

According to Business Week (2008), Southwest Airlines is a passenger airline that provides scheduled air transport in the United States. The company also sells credit to business partners for instance hotels, telecommunication companies, credit card companies and car rental agencies.

The Southwest Airline Company was founded in 1967 under the initial name of Air Southwest which was later changed to Southwest Airlines in the early 1970s.

The company’s headquarters are in Dallas, Texas with a large focus city at McCarran International Airport in Las Vegas. The number of passengers carried domestically, annually is the highest in the United States and in the world over.

By revenue, Southwest airlines are the sixth-largest airline in the United States which makes it one of the most profitable airlines in the world. This is what led to Southwest Airlines posted a profit for the thirty-fifth consecutive year in the month of January 2008. It also maintains the fifth largest passenger fleet of aircraft amongst all the commercial airlines globally (Freiberg, 1996).

Southwest Airlines uses short-haul routes and point-to-point service where their flights operate from one city to the other. The airline complements its services by increasing the number of medium to long-haul routes which include transcontinental service.

There are a number of factors to which the airlines’ success can be attributed. Its approaches when compared to those used by other airlines are quite different. The method of payment of the crew they apply is by trips. Their crew is one of the best paid in the industry. This must contribute to the high quality of service output. The airline does not assign seats to any particular passengers. Instead, there is just one class of travel for all the passengers. In an effort to make traveling more relaxing for their customers, the airlines usually use the less congested airports. With a combination of low airfares, the airline has been able to attract very high numbers of passengers. The Fortune Magazine once referred to the airline as “the hottest thing in the sky” (Serwer, 2004).

According to Freiberg (1996), Southwest airlines’ profitability has not always been stable; the company had to deal with financial constraints, especially in the early 1970s. This can be said to be what led the company to adopt financial techniques so as to first, boost its profitability then, deal with some fuel complications which rose or were expected to rise within the course of the airline’s operations. The fuel cost containment was later what came to be established as one of the major reasons why the company succeeded in maintaining its profit margins. The fuel cost containment strategy was implemented by the airline in order to ensure future fuel costs fluctuations are not only predicted but are appropriately planned for in advance. The strategy was called ‘The Hedging Strategy’ and it enabled the airline to secure fuel at considerably low costs (Banstettor, 2002).

Southwest Airlines is the only airline that maintains an investment-grade rating on the debts incurred which in the airline industry is a great accomplishment. The company’s officials point out that this is part of the company’s culture (Serwer, 2004).

Southwest Airlines’ financial developments within a four-year time period show that the gross profit of the company as of 2004 was US$ 1,760 million but by the year 2007 the same had increased to an amount of US$ 2,505 million. The total revenue as stated in the income statement of the year 2007 was a total amount of US$ 9,161 million compared to that of 2004 when the total revenue was US$ 6,530. The Net Income for the year 2007 was a total of US$ 645 as compared to the 2004 amount of US$ 215 (Reuters).

Ratio Analysis

The different ratios are; The Gross Margin ratio which is the five-year average for the company is 28.37 while the five-year average gross margin ratio for the industry is 23.11. This is an indication that Southwest airlines are performing above average in terms of profitability in the industry.

The Net profit margin for the company is 5.86 while for the industry the ratio was 1.95. This shows that the company is more profitable than most of the other companies in the industry. The Quick ratio for the company is 1.03 while the same for the industry is 0.92. This is an indication of the company’s high liquidity. The Current Ratio (MRQ) for the company is 1.07 while that for the industry is 1.03.

All the above comparisons of Southwest airlines’ financial ratios with those of the airlines industry indicate that it is generally doing better financially than most of the other airlines in the same industry.

Income statement for Southwest Airlines

In Millions of USD (except for per share items)	12 months Ending 2007-12-31	12 months Ending 2006-12-31	12 months Ending 2005-12-31	12 months Ending 2004-12-31
Revenue	9,587.00	8,884.00	7,412.00	6,397.00
Other Revenue, Total	274.00	202.00	172.00	133.00
Total Revenue	9,861.00	9,086.00	7,584.00	6,530.00

Cost of Revenue, Total	7,081.00	6,311.00	5,186.00	4,637.00
Gross Profit	2,506.00	2,573.00	2,226.00	1,760.00

Selling/General/Admin. Expenses, Total	–	–	–	–
Research & Development	–	–	–	–
Depreciation/Amortization	555.00	515.00	469.00	431.00
Interest Expense (Income) – Net Operating	–	–	–	–
Unusual Expense (Income)	–	–	–	–
Other Operating Expenses, Total	1,434.00	1,326.00	1,204.00	1,058.00
Total Operating Expense	9,070.00	8,152.00	6,859.00	6,126.00

Operating Income	791.00	934.00	725.00	404.00

Interest Income (Expense), Net Non-Operating	-25.00	7.00	-36.00	-28.00
Gain (Loss) on Sale of Assets	–	–	–	–
Other, Net	292.00	-151.00	90.00	-37.00
Income Before Tax	1,058.00	790.00	779.00	339.00

Income After Tax	645.00	499.00	484.00	215.00

Minority Interest	–	–	–	–
Equity In Affiliates	–	–	–	–
Net Income Before Extra. Items	645.00	499.00	484.00	215.00

Accounting Change	–	–	–	–
Discontinued Operations	–	–	–	–
Extraordinary Item	–	–	–	–
Net Income	645.00	499.00	484.00	215.00

Preferred Dividends	–	–	–	–
Income Available to Common Excl. Extra Items	645.00	499.00	484.00	215.00

Income Available to Common Incl. Extra Items	645.00	499.00	484.00	215.00

Basic Weighted Average Shares	–	–	–	–
Basic EPS Excluding Extraordinary Items	–	–	–	–
Basic EPS Including Extraordinary Items	–	–	–	–

Dilution Adjustment	–	–	–	0.00
Diluted Weighted Average Shares	768.00	824.00	806.00	804.00
Diluted EPS Excluding Extraordinary Items	0.84	0.61	0.60	0.27

Diluted EPS Including Extraordinary Items	–	–	–	–

Dividends per Share – Common Stock Primary Issue	0.02	0.02	0.02	0.02
Gross Dividends – Common Stock	–	–	–	–
Net Income after Stock Based Comp. Expense	–	–	–	–
Basic EPS after Stock Based Comp. Expense	–	–	–	–
Diluted EPS after Stock Based Comp. Expense	–	–	–	–
Depreciation, Supplemental	–	–	–	–
Total Special Items	–	–	–	–
Normalized Income Before Taxes	–	–	–	–
Effect of Special Items on Income Taxes	–	–	–	–
Income Taxes Ex. Impact of Special Items	–	–	–	–
Normalized Income After Taxes	–	–	–	–
Normalized Income Avail. to Common	–	–	–	–
Basic Normalized EPS	–	–	–	–
Diluted Normalized EPS	0.84	0.61	0.60	0.27

Source: Reuters (NYSE: LUV).

Southwest Airlines Corporation Balance Sheet

In Millions of USD (except for per share items)	As of 2007-12-31	As of 2006-12-31	As of 2005-12-31	As of 2004-12-31
Cash & Equivalents	2,213.00	1,390.00	2,280.00	1,048.00
Short Term Investments	566.00	369.00	251.00	257.00
Cash and Short Term Investments	2,779.00	1,759.00	2,531.00	1,305.00
Accounts Receivable – Trade, Net	279.00	241.00	258.00	248.00
Receivables – Other	–	–	–	–
Total Receivables, Net	279.00	241.00	258.00	248.00
Total Inventory	259.00	181.00	150.00	137.00
Prepaid Expenses	57.00	51.00	40.00	54.00
Other Current Assets, Total	1,069.00	369.00	641.00	428.00
Total Current Assets	4,443.00	2,601.00	3,620.00	2,172.00

Property/Plant/Equipment, Total – Gross	15,160.00	13,859.00	12,508.00	11,921.00
Goodwill, Net	–	–	–	–
Intangibles, Net	–	–	–	–
Long Term Investments	–	–	–	–
Other Long Term Assets, Total	1,455.00	765.00	1,171.00	442.00
Total Assets	16,772.00	13,460.00	14,003.00	11,337.00

Accounts Payable	759.00	643.00	524.00	420.00
Accrued Expenses	2,737.00	1,245.00	1,585.00	829.00
Notes Payable/Short Term Debt	0.00	0.00	0.00	0.00
Current Port. of LT Debt/Capital Leases	41.00	122.00	601.00	146.00
Other Current liabilities, Total	1,301.00	877.00	1,138.00	747.00
Total Current Liabilities	4,838.00	2,887.00	3,848.00	2,142.00

Long Term Debt	2,050.00	1,567.00	1,394.00	1,700.00
Capital Lease Obligations	–	–	–	–
Total Long Term Debt	2,050.00	1,567.00	1,394.00	1,700.00

Total Debt	2,091.00	1,689.00	1,995.00	1,846.00

Deferred Income Tax	2,535.00	2,104.00	1,681.00	1,610.00
Minority Interest	–	–	–	–
Other Liabilities, Total	408.00	453.00	405.00	361.00
Total Liabilities	9,831.00	7,011.00	7,328.00	5,813.00

Redeemable Preferred Stock, Total	–	–	–	–
Preferred Stock – Non Redeemable, Net	–	–	–	–
Common Stock, Total	808.00	808.00	802.00	790.00
Additional Paid-In Capital	1,207.00	1,142.00	963.00	299.00
Retained Earnings (Accumulated Deficit)	4,788.00	4,307.00	4,018.00	4,089.00
Treasury Stock – Common	-1,103.00	-390.00	0.00	-71.00
Other Equity, Total	1,241.00	582.00	892.00	417.00
Total Equity	6,941.00	6,449.00	6,675.00	5,524.00

Total Liabilities & Shareholders’ Equity	16,772.00	13,460.00	14,003.00	11,337.00

Shares Outs – Common Stock Primary Issue	–	–	–	–
Total Common Shares Outstanding	734.80	783.31	801.64	784.98

Source: Reuters (NYSE: LUV).

References

Banstettor, T (2002). Ahead of the pack”. Fort worth Star-Telegram Business Week (2006). Business Week.

Freiberg, K & Freiberg, J (1996). NUTS! Southwest Airlines’ Crazy Recipe for business and Personal Success. Austin: Bard Press, Inc.

Reuters. (2006.). Financial Statements. Reuters Business and Finance. Web.

Serwer, A (2004). “Southwest Airlines: The hottest thing in the Sky”. Fortune.

Southwest Airlines Co. (2006.). Travel and Tourism. Southwest Airlines Co. Web.

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