Financial Performance of Low-Cost and Full-Service Airlines in Times of Crisis, The

Canadian Journal of Administrative Sciences, Mar 2005 by Flouris, Triant, Walker, Thomas John

Current Ratio = Current Assets / Current Liabilities

Activity ratios: total asset turnover. The total asset turnover is a measure of how efficiently and effectively a company uses its assets to generate sales. The higher the total asset turnover ratio, the more efficiently a firm's assets have been used. We calculate the total asset turnover ratio as follows:

Total Asset Turnover = Sales / Total Assets

Financing ratios: debt ratio and interest coverage ratio. Debt ratio is a simple but effective ratio that indicates the firm's debt-paying ability in the long run. The ratio represents the percentage of assets financed by creditors, and helps to determine how well the creditors are protected in case of insolvency. The higher the ratio, the greater the degree of outside financing by creditors. A high debt ratio indicates that the firm is more leveraged (has more debt) and is risky for creditors. We calculate the debt ratio as follows:

Debt Ratio = Total Liabilities / Total Assets

The interest coverage ratio (sometimes refereed to as "times interest earned") measures the ability of the firm to service all debts. The figure measures how many times interest payments could be made with a firm's earnings before interest expenses and taxes are paid. The higher the ratio, the more likely the firm can meet its obligations. The figure is determined by the following formula:

Interest Coverage Ratio = EBIT / Interest

Profitability ratios: net profit margin, return on assets, and return on equity. The net profit margin measures the amount of profits available to shareholders after interest and taxes have been deducted on the income statement. It is calculated as follows:

Net Profit Margin = Net Income / Sales

The return on assets (ROA) ratio measures the firm's ability to utilize its assets to create profits by comparing profits with the assets that generate profits. It is calculated as follows:

ROA = Net Income / Total Assets

The return on equity (ROE) measures the return earned on the owners' equity in the firm. The higher the rate, the better the firm has increased wealth to shareholders. The basic formula is as follows:

ROE = Net Income / Stockholders' Equity

Stock Performance Analysis

To examine the impact of 9/11 on the stock performance of our sample airlines, we follow the event study procedure described in Brown and Warner (1985), Peterson (1989), and Schweitzer (1989). Event study methodology measures the abnormal return of the stock, as the difference between the actual return and the expected return, around the time of the event. If an announcement such as news of increased profits is taken as good news, abnormal returns will be positive, signaling the market's belief that firm value has increased. A negative abnormal return is evidence of bad news, indicating that the market believes the event will decrease the firm's future profitability.

Cornell, Hirshleifer, and James (1997) review many of the practical issues in beta selection and the application of regression-based asset-pricing models to estimating equity cost of capital. They provide assistance for resolving many of the conventional problems with beta estimation, such as selection of the risk-free rate, the time period for estimation, and the inclusion or exclusion of dividends.