Pearson BTEC Level 4/5 HNC/D Diploma Travel and Tourism Management - Unit 2 : Managing Finance in Travel and Tourism Sector

Unit Description

Introduction

In this Managing Finance Travel Tourism Sector we have analyzed travel and tourism industry with the help of taking British Airways as an example. Different aspects of finance like costing methodology adopted by the firms in the industry, usefulness of the management accounting information, making use of budget, interpretation of the financial ratios of the firm and lastly the financing options available with such firms have been explored below. An in depth analysis of all these aspects has been done keeping in mind British Airways. This Managing Finance Travel Tourism Sector has helped to gain an insight about the travel industry.

LO1:

Analyse and discuss the methods of costing and the concept of cost, volume and profit in the travel and tourism industry using the given company as the example. Discuss how the pricing strategies are adopted in the travel and tourism sector using the case study example.

Cost is an important part of the business strategy for travel and tourism industry. This industry provides services and hence the products are not tangible. There are intangible elements like the way staff treats its people or the facilities being provided by the firm which can be used as differentiating factor. Many travel firms charge higher cost for their premium services. Thus the firm need to understand on what services are they providing to the customers and are the customers willing to pay for these services. This industry is also very competitive. There are many players in the market who are trying to woo the customers and hence cost also becomes a factor for the customers to decide from where they want to take the services. Thus a balance between cost and service becomes an important factor in this industry.

Managing Finance in Travel Tourism Sector

There are different ways of deciding on the price of the services. Firms can use the standardized costing, contribution concept or can use ABC costing technique. In addition to this firm also have flexible costing where the cost changes according to the supply and demand and time left to provide the service. As the date draws near prices tend to increase for such firms. Cost can be classified according to the products, function and nature of the services being offered by the firm. Here we industry being considered is travel and tourism and they mostly provide services else for firm selling products, cost can be divided into production and non production costs.

Here British Airways have been taken as the example to explain the concept of cost. Here the firm follows the contribution pricing with some modifications. It also has the flexible pricing system and charges higher cost for premium costing technique. British Airways have high fixed cost which is of the fuel and the planes. However it tries to incorporate the variable cost into the pricing and tries to increase the volume of the customers so as to cover the fixed costs. Also it provides different services depending upon the cost. Hence the customers who are willing to pay more can do so and take the benefit of premium services. Thus the costing in this industry is flexible and is also affected by external factors (Dyson , 2003)

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LO2:

Analyze the role of management accounting information as a decision making tool in your case study organization and Identify and discuss the objectives of a budget and assess its importance generally with special emphasis in the travel and tourism industry:

Tourism and travel industry need to use management accounting information in order be competitive. Firm needs to understand its costs like the cost of its assets, equity in order to pricing decision making. There have been many cases where a firm is not able to identify the real costs and thus has led to firm adopting incorrect pricing strategy which led to failures of the firm. Firm need to understand its cost and the best way to do is to analyze its accounting information. Firm can analyze its assets, its equity, liabilities and thus come up with the cost of these in the balance sheet of the firm. Analysis of the cost can be done using this management accounting information. This cost would be used to make pricing decisions.

Important information which the firm can use to make important decisions is the budget of the firm. Travel and tourism industry mostly have seasonal sales. As a result the firm needs to have a strong and robust budget which helps the firm incorporates seasonality in decision making process of the firm. Firm need to be ready during the times of the year when the sales are expected to increase and more number of customers are expected to use firm’s services.

A good budget can help the firm gather idea about the expected sales in the future and how should the firm ramp up their services in order to serve the expected increase in the sales of the firm. Similarly firm need to understand when the sales are expected to go down and hence they need to cautious and not invest too much in their resources as it can lead to wastage. Thus the firm should always be ready to serve its customers. Lack of resources to serve the customers should never become an issue for the firm as it can lead to loss of reputation for the firm. Thus budgeting becomes very important for the firm like British Airways who are in the business of the travel and tourism.

An example of this can be taken for British Airways. Firm needs to analyze the periods during the year in which the no of people travelling peaks and this will be repeated phenomena for the firm. Hence the firm needs to prepared when the this part of the year arrives. Normally during holiday season a travel industry sees more bookings and hence the firm normally charges higher than the normal rates. However they also need to have their resources so that they can service the customer better.


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LO3:

Using the financial statements of the company provided, interpret the financial statements using appropriate ratios for profitability, liquidity, efficiency, investment and insolvency.

The firm which has been chosen for checking the financials ratios is British Airways. The financial ratios are shown in Appendix as asked in the question.

Interpretation of the financial ratios:

The ratios are divided into liquidity ratios, solvency ratios, profitability ratios and investment and efficiency ratios.

In liquidity ratios there are three ratios which have been considered. First ratio is the current ratio which is equal to current assets divided by the current liabilities. Second ratio is current assets minus inventories divided by liabilities. Third ratio is the cash divided by the current liabilities. Ideally all the three ratios should be above 1.  This may not be the case every time but current ratio should be above 1. If the ratio is below it indicates that the firm needs to increase its short term assets. Here all the three ratios are below than 1. Current ratio is 0.6 and the firm needs to work to increase its short term assets.

In profitability ratios there are two ratios which are operating profit margin, net income margin. The operating profit margin is 6.43% and the net income margin is 2.77%. This margin is very less and the firm needs to work on improvising this margin. This low margin will translate into very low profit.

Next set of ratios are the long term ratios which are the solvency ratios. These ratios give information about the long term solvency of the firm. First ratio is the debt to equity ratio. This ratio should be as less as possible. Here debt to equity ratio is 1.4. This ratio is well below the danger level of 2. Ideally if the ratio starts rising above 2 then it can create problem for the firms. High level of debt raises the riskiness of the firm. Debt comes with a fixed commitment of interest costs. Hence as the debt increases the fixed annual interest cost increases which can create issues for the firm if it is not able to generate enough operating income. To check another ratio known as the interest leverage ratio is used to check of the firm will be able the interest payments with the help of the operating income. This ratio is also known as the interest coverage ratio. If this ratio is above 1 it indicates that the firm will be  able to serve its interest payments comfortably. Here the firm ratio is above 1 and is equal to 3.4 which indicates that the firm will be able to make comfortably. Another ratio in this section is the debt ratio. This ratio informs the user whether the firm assets are enough to payback the debt of the firm in case of any issues. This ratio is approximately 0.29 and hence this indicates that the firm has enough assets to payback its debt (Drury, 2003).

Another set of ratios which have been analyzed are the investment and the efficiency ratios. These ratios inform the user whether the firm is able to make appropriate use of its assets and if the firm is giving enough returns so that the investors can make investment in the firm.

Return on assets is the net income by the total assets of the firm. Here return on assets for the firm is 2.36% which indicates that the firm return on assets is relatively less. The firm needs to increase this ratio and generate more net income given the asset size of the firm. Another ratio is the return on capital. This ratio informs the user if the firm is able to make appropriate use of its capital. Here the ratio is 11.26& which is okay for such firms however there is still scope for improvement and the firm can look to improve its ratio (Wood & Sangster, 2008).

Thus we have looked at different financial ratios of the firm and make appropriate recommendations for respective ratios.

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LO4:

Identify appropriate sources of finance for the company to expand its operations. Any analysis must include advantages, disadvantages and contrasts for each source of finance

Firm has different options to raise capital for different purposes. These options are majorly classified as debt, equity and hybrid (combination of debt and equity). In each of the section there are different options available to the firm with the help of which it can raise money.

Financing Options

Equity

A company can issue to equity to the investors and raise money, if the business is willing to dilute its stake. Equity is a good option to raise the money as it is less risky than debt and also business can raise large amount of the fund if the business is doing pretty well. In equity too there are different types of options available to raise share. Company can go for ordinary equity. It may also raise money through preference share if it doesn’t want to dilute its voting rights. Company may go public or sell it to private investor (Damodaran, 2007).

Loan from Bank

Another most common source of fund is loan from bank. Depending on the past business performance bank will charge interest on the loan. Bank gives loan for short term purpose i.e. working capital management on a revolving basis and also can give loans for extended period of time (Damodaran, 2007).

Bonds

Company can also issue bonds to the public and it is also a good source of funding. However to avail this type of funding, investors should know about the company and it should be independently rated to decide on the interest rate.

The above mentioned sources of funding are the common among the firms. Company can also use certain unconventional methods like the following:

Leasing

Leasing is a option which is widely used by the companies. In this option,  the firm doesn’t buy the equipments but instead takes it on lease from another company and pays a regular annual amount on it (Damodaran, 2007).

Hire Purchase agreement

Its similar to leasing but at the end of the last of installment the firm needs to buy the equipment. In leasing the firm may have the option to buy the equipment but it’s necessary.

Asset Based borrowing

Investors can also borrow on their assets and get funding.

There are also small business investors who can provide funding to the business

As discussed above debt and equity are the two main ways of the raising capital and the major source of finances for the firm. Firm need keep a balance between the two options. Debt tends to be less costly as compared to equity. Firm cost of debt is normally considerably less as compared to equity. Also interest payments of debt are tax deductible and thus this is another advantage of debt. Thus the cost of debt is taken as after tax cost of debt. For equity the dividends are not tax deductible and they are included after net income in the balance sheet. However increasing debt in the balance sheet increases the riskiness of the firm. If the firm increases its debt beyond a certain level then the firm may face liquidity issues and hence the firm cannot increase the debt beyond a certain levels as the benefits due to taking in more debt starts decreasing.

In terms of affecting the financial statement debt tends to increase the long term liability of the firm and it increases the expenses in terms of the interest payments. However this cost is tax deductible. If the firm is taking lease then depending on terms and conditions which classifies the lease as capital or operating lease it will have different effects on the balance sheet and the income statement. Capital lease is more like a debt while the operating lease will be more like a equipment on rent.

Equity will increase the owners’ s equity section of the firm. Increasing equity will mean that the firm will need to give out more dividends. This appears post net income after tax. Thus dividends of the firm are not tax deductible.

Conclusion

Travel industry dynamics are different from other industries and thus the managing finance of such firms are also different. Here British Airways has been used as an example to understand the dynamics of the travel industry. Using different aspects of cost methodology it was seen that the firm follows flexible contribution costing policy, how the firm can make use of the accounting information and also how can it effectively use budget to save its costs and increase the customer experience. Its financial ratios were looked and finally the different financing options available to the firm were analyzed. Thus a complete overview was taken for the firm.

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