cambridge year 12 (hsc) business studies fourth edition...cambridge year 12 (hsc) business studies...

Case Study – Virgin

Cambridge University Press 1 © Hickey et al 2018

Cambridge Year 12 (HSC) Business Studies Fourth Edition

2019 Updates

Chapter 15A – Finance at Virgin Australia

Chapter objectives

In this chapter, students will:

• investigate the role of financial management at Virgin Australia

• analyse the influences on financial management at Virgin Australia

• explain the processes of financial management at Virgin Australia

• evaluate financial management strategies at Virgin Australia.



15.1 Role of financial management

Strategic role of financial management

Virgin Blue began as a low-cost airline servicing the Australian domestic market.

Strategic planning has enabled this business to grow and become a major

competitor to Qantas as a domestic carrier. The business has also expanded to

provide premium services to the local and international market. As early as 2001, the

company recognised the significant need for finance and completed an agreement

with Patrick Corporation to invest $260 million in Virgin Blue in exchange for a 50 per

cent share of the company. As Patrick Corporation is an Australian company and

eventually owned more than 60 per cent of Virgin Blue, Virgin Blue was therefore

also classified as Australian-owned.

Source 15A.1 Virgin Blue and Virgin Australia logos

Virgin Australia is a business heavily reliant on finance due to its need for large-scale

assets such as aircraft and equipment for maintenance facilities. It has a staff of 10

151 in Australia, including employees from its subsidiaries, and significant fuel costs

to operate its fleet of 133 aircraft.



Source 15A.2 The finance department is made up of several divisions.

Objectives of financial management

In the 2011 financial year Virgin Australia introduced a strategic plan based on its

Game Change program. In Virgin’s 2014 Annual Report the company explained that

the overall goal of this strategy was ‘… designed to position the Group as the airline

of choice in all market segments and ensure delivery of sustainable earnings

benefits to the business in the future’ (p. 17). The strategy is divided into several

phases (also outlined in the 2014 Annual Report) and through successful application

the first and second phases were achieved earlier than planned.

Game Change Program Phase 1, 2011 aimed to:

1 Ensure Virgin Australia’s capacity is closely aligned to profitability

2 Establish a virtual global network through strategic airline alliances

3 Grow Virgin Australia’s share of the Australian corporate business from 10 per

cent to 20 per cent

4 Maintain Virgin Australia’s strong presence in the leisure market

5 Enhance Virgin Australia’s already strong brand in Australia and in overseas

markets.



Phase 2: Game On, 2013 financial year, was based on the following key strategies:

1 Implementing a business efficiency project

2 Building a transformational loyalty business

3 Increasing access to global markets

4 Further enhancing the guest experience through in-flight and on-the-ground

innovation

5 Continuing to develop Virgin Australia’s people and service excellence.

Game On revolved around driving new growth opportunities for the business, while

retaining a cost-efficient, flexible business model. In line with the Game Change

program, Virgin Australia acquired 100 per cent of SkyWest Airlines (a Western

Australian operation) in May 2013 to develop a new growth charter market in

regional Australia to service clients in the resource industry. In July 2013, through

the acquisition of 60 per cent of Tigerair Australia, the airline re-entered the budget

travel market segment. By the end of the 2014 financial year, Virgin had also

acquired 25 per cent of the domestic revenue of the corporate and government

market segment (5% over its goal of 20% in aim number 3 of Phase 1).

Source 15A.3 The acquisition of SkyWest and Tigerair have been identified as reasons for Virgin’s losses in 2013 and 2014.

Virgin has now moved on to Phase 3: Virgin Vision 2017, a three-year strategy that

intends:

1 Capitalising on growth business opportunities

2 Driving yield enhancement

3 Implementing a new cost program

4 Optimising the Balance Sheet

5 Setting a new standard in customer experience

6 Developing Virgin Australia’s people to their full capacity.



Collectively, the phases are directed to enabling Virgin to deliver a sustainable and

profitable business over the long term. While still ongoing, the Virgin Vision 2017 has

provided goals for Virgin staff to work towards. In 2018, through the Better Business

program, Virgin has continued to place a high priority on improving its cash flow

situation and overall efficiency levels. This program, covering a three-year period,

incorporated a review of Virgin’s capital structure and significant steps to strengthen

the balance sheet. As part of the growth business opportunities, Virgin’s Velocity

Frequent Flyer Program achieved 9.1 million members by July 2018. In 2018 Virgin

Australia was awarded ‘Best Domestic Airline’ by the Australian Federation of Travel

Agents; achieved a five-star rating by the Airline Passenger Experience Association;

and was rated ‘Best Business Class’ and fourth globally by Airline Ratings.

Additionally, it was awarded ‘Program of the Year’, ‘Best Elite Program’, ‘Best

Customer Service’ and ‘Best Redemption Ability’ in the Freddie Awards.

Short-term and long-term

2018 delivered a significant improvement on previous years for Virgin Australia. An

underlying profit before tax of $109.6 million delivered a $113.3 million boost on the

2017 financial year result, and the highest result since 2008.

The group reported a Statutory Loss after Tax of $653.3 million for the 2018 financial

year. This was mainly driven by approximately $573.3 million in non-cash accounting

adjustments (e.g. depreciation) and continued restructuring charges from the Better

Business program.

There was a lot of work done at the group level in order to stabilise the company’s

financial situation, including smaller shareholders with holdings of $500 or less,

exiting their shareholdings through a buy-back where 19 800 shareholders exited

their ownership. This resulted in 0.15 per cent of the group’s issued capital being

bought back and cancelled. Since 2017, business changes have included:

• improvement of 108 per cent in net cash flow from operating activities

• 113.1 per cent improvement in free cash flow

• 13 per cent improvement in financial leverage

• Velocity Frequent Flyers increased membership to 9.1 million



• continued improvement from the Better Business program such as cash flow

savings of $324 million for 2018.

Virgin Australia’s strategic plans are heavily reliant on financial management.

Financial objectives include long-term growth, future profitability and solvency. In the

short term, tactical and operational financial plans are developed so that the airline

remains efficient by eliminating unnecessary expenses, ensures adequate cash

inflow to maintain liquidity and continues to maintain its customers with superior

service to ensure loyalty to the Virgin brand. This required all of the interdependent

functions of the business to work collectively to achieve the business’s goals.

Management ensures that it will always have sufficient liquidity to meet liabilities

when they fall due, and that it maintains sufficient cash, securities and lines of credit

to ensure its liquidity. At the end of the 2018 financial year, Virgin held cash and

cash equivalents supported through debt and equity financing of $1415.5 million and

an unrestricted cash balance of $1000.8 million.



15.2 Influences on financial management

Internal sources of finance

Retained profit

Source 15A.4 Retained profit for financial years since 2011

End of financial year Retained profit

2011 $220.2m

2012 $243m

2013 $212.1m

2014 ($143.5m)

2015 $253.6m

2016 $332.1m

2017 ($734.8m)

2018 ($1415.8m)

Source 15A.5 Operating segments results 2018

2018 $m

2017 $m

Movement $m

Movement %

Revenue and income

Virgin Australia Domestic 3 664.0 3 439.6 224.4 6.5

Virgin Australia International 1 120.3 999.0 121.3 12.1



Velocity 372.0 371.0 1.0 0.3

Tigerair Australia 570.6 543.3 27.3 5.0

Segment EBIT

Virgin Australia Domestic 246.1 92.9 153.2 164.9

Virgin Australia International (12.8) 0.5 (13.3) N/M

Velocity 110.1 142.8 (32.7) (22.9)

Tigerair Australia (36.2) (24.3) (11.9) (49.0)

Source 15A.5 shows that all segments have seen an increase in revenue for the

2018 financial year. However, both Tigerair and the international segments suffered

increased costs resulting in negative profits.

External sources of finance

Debt

Virgin Australia utilises bank loans and leasing finance for several of its aircraft.

Source 15A.6 Debt finance used by Virgin in the 2018 financial year

Carrying/drawn amount

$m

Facility limit $m

Currency Calendar year of principal repayments

2018 2017 2018 2017



Secured bank

loans

––Aircraft AUD 2018–30 262.2 84.6 262.2 123.7

––Aircraft USD 2018–28 898.6 1 125.1 898.6 1 125.1

––Other AUD 2020 220.6 218.3 224.1 264.4

Unsecured loans

––Other AUD N/A – – 1.2 12.2

––Unsecured

bonds

AUD 2023 148.1 – 148.1 –

––Unsecured

bonds

USD 2019–21 1 003.5 964.8 1 003.5 964.8

Finance leases AUD 2018–47 23.1 40.5 23.1 40.5

Finance leases USD 2018–20 12.0 – 12.0 –

Standby letters of

credit and bank

guarantees

AUD and

USD

2018–27 179.9 122.2 220.5 162.2

2 748.0 2555.5 2 793.3 2 692.9

Overview of company performance

Source 15A.7 provides summary information on the group’s financial performance

and the effect on shareholder wealth for the five years to 30 June 2018.



Source 15A.7 Overview of company performance 2018

Financial year 2018 2017 2016 2015 2014

Segment EBIT ($m) 259.5 164.1 210.6 65.9 (126.0)

Underlying group profit/(loss)

before tax ($m)

109.6 (3.7) 41.0 (49.1) (211.7)

Net (loss)/profit attributable to

owners ($m)

(681.0) (220.3) (260.9) (110.8) (353.8)

Share price ($) 0.22 0.16 0.21 0.43 0.43

Change in share price ($) 0.06 (0.05) (0.22) – –

Dividends paid ($m) – – – – –

EPS (cents) (8.1) (2.8) (7.4) (3.2) (11.4)

ROIC (%) 10.5 8.3 8.9 6.1 1.7

Equity

As early as 2002, Virgin Blue’s agreement with Patrick Corporation was essentially

for it to invest $260 million in the airline in exchange for 50 per cent ownership. Virgin

Australia is a public company floated on the Australian Securities Exchange (ASX)

as Virgin Blue Holdings Limited in 2003.

As more growth finance was needed, more equity was obtained. More recently:

• on 1 July 2015, Virgin Australia launched its Cargo business, offering cargo

space on over 3000 flights per week across the group’s network, with access

to specialist cargo handling terminals in all major Australian airports



• on 31 May 2016, Virgin Australia formed an alliance with HNA Aviation Group

Co. Ltd (HNA). The alliance included codesharing, frequent flyer programs,

tourism, and $158 million new shares to HNA.

• on 10 June 2016, Air New Zealand Limited sold most of its shares (19.98%) to

China’s Nanshan Group

• on 15 June 2016, the Board announced it would raise equity of $852.0 million

through a fully underwritten one for one pro-rata non-renounceable

entitlement offer of $852.0 million.

Air New Zealand’s strategy to gain access to the Australian domestic airline market

has been through investment in Virgin of approximately $400 million over the years.

No dividends were paid to shareholders for the 2016, 2017 or 2018 financial years.

On 30 June 2018 the share price of Virgin Australia Holdings was 22 cents per

share, down from a high of 43 cents per share in 2014–15.

The group issued 342 million fully paid ordinary shares to HNA in September 2016.

In 2018, total equity decreased by $478.8 million due to a statutory loss after tax of

$653.3 million; as well as an equity redistribution (such as the share buy-back) of

$47.1 million.

Influence of government

Virgin Australia had to pay $47.9 million in carbon tax in the 2013 financial year.

Plans to pass this on to passengers as a carbon surcharge were abandoned due to

the strong and aggressive price competition in the marketplace with Qantas. This tax

was an expense for the business and impacted on the final profit figures. (This tax

has since been repealed.)

The two major competitors in the industry are Virgin Australia and Qantas. Virgin is

not subject to the same foreign ownership restrictions as Qantas due to the Qantas

Sale Act 1992 and amendment Bill in 2014 to repeal section 3 to allow Qantas to be

included as an Australian International airline allowing foreign ownership to increase



from 25 to 49 per cent. This increased the competitiveness of Qantas in relation to

Virgin Australia.

Also, several of Virgin’s main shareholders are individually backed by their own

governments; for example, the Singapore government’s investment and holding

company currently owns 56 per cent of Singapore Airlines.

The goods and services tax (GST) is recognised as part of the cost of assets

purchased and therefore as part of the expense. All accounts receivable and

accounts payable are recorded with the amount of GST included.

The airline is subject to a 30 per cent company tax rate in Australia as its

headquarters are registered in Australia. The airline is also subject to airport

charges, navigation and station operations passengers’ charges at all destinations.

In addition, all ownership proposals and agreements need to be reviewed by the

Australian Securities and Investments Commission (ASIC) and ASX in order to

evaluate their effect on consumers and competitors and to ensure that stakeholders

are not disadvantaged.

Global market influences

Virgin Australia’s market risk management takes part in hedging to attempt to

discount the threat of increased international interest rates and volatile exchange

rates, using forward foreign exchange contracts due to the weakening Australian

dollar, as well as contracts for fuel, which result in increased costs and planning

problems. Derivative financial instrument asset balances have increased by $275

million to $284 million in 2018. The Virgin board has determined hedging limits for

financial risk under the authorised limits set by the Australian Treasury Risk

Management Policy.



15.3 Processes of financial management

Planning and implementing

Financial needs

While the 2018 result is a $467.5 million increase on 2017, the result was a loss after

tax of $653.3 million. Revenue was up, with a $373.4 million increase on the year

before, but factors including fleet improvements, maintenance and resourcing that

are part of the longer-term plans meant that operating expenditure was also up. The

weaker Australian dollar also had a significant impact on fuel costs, as well as

significant amortisation and depreciation of assets and the payment of deferred

taxation.

The company uses budgets as both planning and control tools. Monthly actual

results are compared to budgets that were approved by the Board and periodically

used to prepare revised forecasts for the year. Since 2014 the Board has directly

linked financial performance to senior executives’ overall remuneration, providing a

weighting on short-term incentives on their ability to remain within the budgeted

costs and achieve overall financial performance for their departments.

Virgin has introduced several record systems to enable the business to better

analyse its initiatives. It has a Flight Data Management Program as part of its safety

management system, using a database to analyse flight data to identify risk. Data is

recorded on flight, cabin and ground operations crews to analyse fatigue risk. Virgin

also introduced SabreSonic, an international online booking system.

Financial risks eventuate from changes in fuel prices, landing fees, government

policy, industrial action, safety problems such as pandemics, terrorism and natural

disasters such as the Bali volcanic eruption of 2018, as well as currency, liquidity and

credit risks.

Financial controls include budgets, hedging and derivatives, and ongoing risk

assessment undertaken to determine their impacts for future financial years.



Monitoring and controlling

Cash Flow Statement

Below is Virgin Australia’s Consolidated Cash Flow Statement for the financial year

ended 30 June 2018.

Source 15A.8 Consolidated cash flow statement

Note 2018 $m

2017 $m

Cash flows from operating activities

Cash receipts from customers 6 099.7 5 657.1

Cash payments to suppliers and employees (5 366.0) (5 131.2)

Cash generated from operating activities 733.7 525.9

Cash payments for business restructuring

expenses

(44.8) (121.8)

Finance income received 19.2 17.0

Finance costs paid (137.7) (147.2)

Net cash from operating activities B6 570.4 273.9

Cash flows from investing activities

Acquisition of property, plant and equipment (546.5) (436.7)

Proceeds on disposal of property, plant and

equipment

D1 7.7 188.0

Acquisition of intangible assets (44.4) (37.2)



Payments for other deposits (56.8) (48.4)

Proceeds from other deposits 77.0 1.2

Dividends from equity-accounted investee – 1.5

Net cash used in investing activities (excluding aircraft operating lease refinancing)

(563.0) (331.6)

Aircraft operating lease refinancing (5.7) –

Net cash used in investing activities (568.7) (331.6)

Cash flows from financing activities

Proceeds from borrowings 356.9 557.0

Repayment of borrowings (307.1) (1098.9)

Payments of transaction costs related to

borrowings

(6.0) (13.1)

Net proceeds from share issue – 931.4

Net payment for share buy-back E4 (5.3) –

Equity distributions paid to non-controlling

interests

F5 (47.1) (38.2)

Net cash (used in)/from financing activities

(8.6) 338.2

Net increase/(decrease) in cash and cash equivalents

(6.9) 280.5



Cash and cash equivalents at 1 July 1 396.1 1 123.8

Effect of exchange rate fluctuations on cash

and cash equivalents

26.3 (8.2)

Cash and cash equivalents at 30 June E2 1 415.5 1 396.1

The consolidated statement of cash flows should be read in conjunction with the

accompanying notes to the consolidated financial statements. Note: At the end of the

financial year for 2018, the Cash Flow Statement leaves the business in an improved

liquidity position compared with 2017. In 2018 cash and cash equivalents were

$1415.5 million while in 2017 they were $1396.1 million.

Income Statement

Below is Virgin Australia’s Consolidated Income Statement for the financial year

ended 30 June 2018.

Source 15A.9 Income statement

Note 2018 $m

Restated 2017 $m

Revenue and income

Airline passenger revenue B3 4 623.4 4 275.3

Other ancillary revenue B3 793.8 765.3

Other income 3.5 3.8

Net foreign exchange gains – 2.9

Revenue and income 5 420.7 5 047.3



Operating expenditure

Aircraft operating lease expenses B4 (389.0) (426.2)

Airport charges, navigation and station

operations

(1 060.7) (1 023.8)

Contract and other maintenance expenses (246.4) (242.6)

Commissions and other marketing and

reservations expenses

(467.4) (430.0)

Fuel and oil (985.5) (898.4)

Labour and staff related expenses (1 246.7) (1 219.2)

Impairment losses on assets classified as

held for sale

D1 – (7.8)

Impairment losses on cash-generating units B4 (120.8) –

Impairment losses on other assets B4 (47.8) (65.9)

Onerous contract expenses C6 (58.5) (29.6)

Other expenses from ordinary activities B4 (512.9) (516.9)

Depreciation and amortisation (337.3) (309.7)

Ineffectiveness on cash flow hedges – 0.7

Net operating expenditure (5 473.0) (5 169.4)

Share of net profit of equity-accounted

investee

F2 3.5 2.1

Loss before net finance costs and tax (48.8) (120.0)



Finance income 19.2 16.9

Finance costs B4 (171.8) (186.5)

Net finance costs (152.6) (169.6)

Loss before tax (201.4) (289.6)

Income tax (expense)/benefit B5 (451.9) 103.8

Loss (653.3) (185.8)

Attributable to:

Owners of the Company (681.0) (220.3)

Non-controlling interests F5 27.7 34.5

(653.3) (185.8)

Earnings per share Cents Cents

Basic earnings per share B2 (8.1) (2.8)

Diluted earnings per share B2 (8.1) (2.8)

The consolidated statement of financial position should be read in conjunction with

the accompanying notes to the consolidated financial statements.

Airline passenger revenue is made up of passenger ticket sales, while other revenue

is earned from the provision of other related services such as freight, on-board sales

and other product revenue.

Virgin Australia’s total revenue increased by approximately 7 per cent from the 2017

to 2018 financial year results. This was mainly due to an increase in passenger



revenue, which increased by $67.9 million, and the Velocity Frequent Flyers

program.

Smaller increases in net operating expenses during 2016 were due to:

• operating lease expenses of $37.2 million more than 2017

• increased airport charges of $36.9 million on 2017

• increase in commissions and other marketing and reservations expenses of

$37.4 million.

However, the majority of the net operating expenditure increased in 2018 due to

provisions and impairment losses. The onerous contract provision (for a reduction in

older aircraft in the fleet) accounts for $246.4 million in expenditure. A further $58.5

million came through impairment losses that have come about due to planned

optimisation of the current fleet – maintenance, engineering, leasehold agreements,

etc. Other factors were depreciation and amortisation (such as for intellectual

property and goodwill) of $337.3 million.

Balance Sheet

Below is Virgin Australia’s Balance Sheet explaining its financial position as at 30

June 2018.

Source 15A.10 Balance sheet

Note 2018 $m

Restated 2017 $m

Current assets

Cash and cash equivalents E2 1 415.5 1 396.1

Receivables C1 281.6 308.9

Inventories C2 47.6 46.3



Derivative financial instruments E7 220.0 2.4

Other financial assets C3 12.1 25.2

Assets classified as held for sale D1 – 4.3

Other C4 2.7 4.3

Total current assets 1 979.5 1 787.5

Non-current assets

Receivables C1 191.6 162.4


Other financial assets C3 284.2 292.5

Investment accounted for using the equity

method

F2 8.2 4.6

Deferred tax assets B5 – 554.2

Property, plant and equipment D2 3 031.0 2 916.6

Intangible assets D3 617.0 617.2

Other C4 12.9 14.2

Total non-current assets 4 208.9 4 568.3

Total assets 6 188.4 6 355.8

Current liabilities

Payables C5 807.5 679.9



Interest-bearing liabilities E3 295.1 280.9


Provisions C6 269.0 234.2

Unearned revenue C7 1 142.1 1 074.2

Other 3.6 22.0

Total current liabilities 2 523.9 2 348.3

Non-current liabilities

Payables C5 5.6 6.3

Interest-bearing liabilities E3 2 273.0 2 152.4


Provisions C6 277.6 263.5

Other 13.1 5.1

Total non-current liabilities 2 569.5 2 433.7

Total liabilities 5 093.4 4 782.0

Net assets 1 095.0 1 573.8

Equity

Share capital E4 2 238.9 2 243.7

Reserves 268.3 58.8

Retained earnings (1 415.8) (734.8)



Equity attributable to the owners of the

Company

1 091.4 1 567.7

Non-controlling interests F5 3.6 6.1

Total equity 1 095.0 1 573.8

The consolidated statement of financial position should be read in conjunction with

the accompanying notes to the consolidated financial statements.

Virgin Australia has decreased its total assets by $167.4 million to $6188.4 million in

2018.

Liabilities have increased by $311.4 million to $5093.4 million in 2018. This is mainly

due to provisions which involve ‘onerous contracts’ – wherein the company has to

meet the obligations of a contract but is not expected to actually recoup enough to

get the benefits of the contract. In 2018, as part of a review, Virgin announced that it

would continue to improve its fleet, both through maintenance and letting go of some

of its older aircraft. The costs associated with this account for the majority of the

liability increase.

Total equity decreased by $478.8 million to $1095 million in 2018, largely due to

significant increases in retained earnings.

Source 15A.11 Virgin Velocity program – 9.1 million members 2018



Financial ratios

Source 15A.12 Financial ratios

Risk 2018 2017

Liquidity Current ratio

Current assets/ current liabilities

1979.5/2523.9 = 0.78:1 (78c in current assets to pay for each $1 of current liability)

1787.5/2348.3 = 0.76:1 (76c in current assets to pay for each $1 of current liability)

Gearing Debt to equity

Total liabilities/ total equity

5093.4/1095.0 = 4.65:1 ($4.65 debt for every $1 of equity) = 82% debt finance

4782.0/1573.8 = 3.04:1 ($3.04 debt for every $1 of equity) = 75.2% debt finance (i.e. 3.04/4.04

Revenue load factor

Revenue passenger kilometres as a % of available seat kilometres

80% 80.2%

Passen-gers carried

24.85m 24.17m

An efficiency ratio

Financial expenses ratio

Financial expenses/ sales revenue

169.6/4985.7 = 3.4% 93.2/4706.0 = 1.098%

Profitability

Return on equity

Earnings per share

(8.1%) (2.8%)

Limitations of financial reports

Financial statements need to be read with the notes to the financial statements. In

Virgin’s case, these additional notes include 52 pages of its 2018 annual financial

report. The details are explained in the statements and reasoning behind the



decisions made. In its case, Virgin explains that its repositioning strategies are aimed

at driving further growth opportunities for the company and an improvement in future

results.

Property, plant and equipment are recorded at historical cost. The cost of these

assets are capitalised as their historical cost includes expenditure that was directly

attributed to their acquisition; for example, major cyclical maintenance costs on

aircraft are capitalised to the value of the aircraft. Transaction costs for equity raising

are capitalised and offset against share capital. Other assets are set at fair value,

based on current market value. At the time of purchase, SkyWest and Tigerair

assets were included through a fair value assessment. (Virgin did not acquire them

as an original purchase and therefore they cannot be valued at historical cost.)

Assets with finite lives are depreciated based on their estimated economic life for

use by Virgin and reviewed each year.

Source 15A.13 Estimated useful life of assets in years

2018 2017

Buildings 10–40 10–40

Aircraft and aeronautic related assets

––Modifications to leased aircraft 6–13 6–13

––Rotables and maintenance parts 9–33 9–33

––Airframe, engines and landing gear 4–22 4–20

––Major cyclical maintenance 1–10 1–10

Plant and equipment

––Leasehold improvements 1–15 1–15

––Other 5–33 5–33



Computer equipment 3–5 3–5

Finance leased assets

––Buildings 34 34

––Aeronautic related assets 4–5 4–5

Liabilities for wages, salaries and annual leave required within 12 months are

included in payables and provisions. Provision is also made for long service leave,

employee bonus plans, superannuation plans, share-based payments to employees

and termination benefits such as redundancy payments.

Ethical issues relating to financial reports

The group follows Virgin’s Guide to Business Conduct and Code of Conduct, which

are both available on the business’s website. According to the Directors’ Report, ‘the

independence of directors is based on their capacity to put the best interests of the

Company and its shareholders ahead of all other interest’. In addition, they support

the ‘Group’s belief that business objectives are best achieved through acting at all

times fairly, honestly and with integrity’. The business has further developed policy

documents that highlight its belief in dealing fairly with its stakeholders such as:

• Keeping Our Workplace Fair policy

• A Fair Go policy

• Gifts policy

• Whistleblower policy (protecting them from adverse behaviour)

• Ethics Hotline (operated through an external independent provider)

• Securities Trading Policy (ensuring that all employees and directors are aware

of the legal restrictions on trading while in the possession of unpublished

sensitive information).



Integrity in financial reporting is upheld through:

1 External and internal audits (KPMG and Virgin’s Audit and Risk Management

Committee)

2 Internal controls to manage risk

3 Compliance with legal, accounting and regulatory requirements and policies.

The CEO and the CFO declare in writing to the Board that the financial records of

the Company for the 2017 and 2018 financial years have been properly maintained

and the annual report complies with Accounting Standards and presents a fair and

true view of the financial position and operating results for the year.



15.4 Financial management strategies

Cash flow management

Virgin ensures that it pays its bills when due. In 2018 it held $1415.5 million in cash

and cash equivalents, increased from 2015 through debt collection. It also held an

unrestricted cash balance of $1000.8 million (up $15 million on the year before).

Virgin has made cash flow a key concern for its business and through the Better

Business program has improved its cash flow management position.

Working capital management

Control of current assets

Receivables: The group had $191.6 million in non-current receivables in 2018 and

an increase of $29.2 million from 2017. This was due to maintenance prepayments

in relation to leased aircraft; and $281.6 million for current receivables, a decrease of

$388.9 million from 2017.

The average credit period for receivables is 14 days, whereas in 2017 it was 16

days. If the customer does not pay the account within the required time period, all

credit for that customer stops. There is no interest charged on trade receivables.

Control of current liabilities

Finance leases are capitalised and amortised over the life of the lease, or over the

life of the asset if they intend keeping the asset. Operating leases are recorded in the

Income Statement as an expense. Aircraft operating lease rentals accounted for

$389.0 million during the 2018 financial period and $426.2 million for 2017. The

group leases buildings and telecommunications and aeronautical related assets. In

2018 the group entered into a financial lease for telecommunications infrastructure

as well as the sale and leaseback of the Brisbane Hangar and five Fokker F100

aircraft. This will be leased until 2047 at which time the group has an option to

extend the lease for an additional 15 years till 2062.



In 2018 the group’s current liabilities were greater than its current assets by $544.4

million, including a current liability for unearned revenue of $1142.1 million. This was

a decrease from the 2017 figure of $560.8 million with unearned revenue of $1074.2

million. Unearned revenue is revenue received in advance and deferred until

carriage is performed. Virgin is aiming to target cost savings through its Better

Business program, which involves changes to its organisational structure, supply

chain, engineering, maintenance and operations. It is aiming for $300 million per

year in net free cash flow savings by the end of 2019. Included in this is the

proposed sale of all Embraer E190s and Tigerair A320s.

Profitability management

Source 15A.14 Net Loss/Profit after tax

Net Loss/Profit after tax

2018 2017 2016 2015 2014 2013 2012

Losses

recorded

as ( )

(653.3m)* (185.8m) (224.7m) (93.8m) ($355.6m) (98.1m) 22.8m

* The 2018 decrease is attributed to the movement in tax expense of $555.7 million as Virgin

domestic and Velocity segments were profitable.

Virgin Australia is now established in all market segments and estimated to have the

lowest cost base of its competitors.

Cost controls

Profit was recorded from the domestic segment, as well as the Velocity Frequent

Flyer program.

Future cost-saving measures include ‘efficiency initiatives’ such as supply chain and

procurement changes; maintenance and engineering efficiency; improved training for

crews and ground operation to minimise disruptions; and the extensive fleet



changes. Reductions were also in restructuring costs and aircraft operating lease

expenses of $37.2 million through its fleet simplification program. Improved finance

costs also led to savings of $17 million. Increased costs arose from airport charges

as the volume of Virgin passengers increased.

Revenue controls

Revenue has increased 8 per cent in 2018 to $5420.7 million from $5047.3 million in

2017.

The largest revenue increase is due to the primary target of airline passenger

revenue and the Velocity program. 2018 saw an increase of $348 million in ticket

sales.

One of Virgin’s most successful strategies has been the use of its loyalty program:

Velocity Frequent Flyer, with 9.1 million reward members.

Successful strategic alliances have created a worldwide network for international

flights flying to 464 destinations across five continents, including 40 city and regional

destinations in Australia. Virgin Australia has strategic alliances with the following

five key airline partners:

• Air New Zealand, resulting in growth in trans-Tasman services (especially for

the ski season), although this was stopped in October 2018, enabling Virgin to

compete in its own right for flights between Australia and New Zealand.

• Delta Air Lines for a trans-Pacific alliance, with access to more than 356

destinations in 65 countries.

• Etihad Airways, with 57 aircraft, 1000 flights per week servicing 67

destinations in 45 countries.

• Singapore Airlines, with an additional 75 destinations, mostly across Asia.

• HNA Aviation Group, including Hong Kong Airlines and Hong Kong Express.

Virgin Australia believes that the Asian and Middle Eastern market will be the two

largest growth areas in the near future.



Global financial management

Exchange rates

Due to its international operations, foreign currency transactions are changed to

Australian currency (or to the entity’s home currency if its registered office is

overseas) at the rates ruling at the date of the transaction. Virgin often completes

transactions in $US such as for the purchase of fuel, aircraft, lease payments, sale of

passenger tickets, and then converts it to the Australian dollar.

Methods of international payments

Letter of credit: Virgin has standby letters of credit available for $124.7 million for the

2016 financial year and $127.3 million for the 2015 financial year.

Hedging

The majority of transactions for fuel, aircraft, lease payments and the sale of

passenger tickets are completed in $US, which is the currency for most of the

group’s asset base. The group enters into fuel contracts in Australian dollars and

then forwards exchange and option contracts to purchase $US.

Source 15A.15 Virgin’s forward foreign exchange and fuel hedging, 2018

2018 $m

2017 $m

Current assets

Forward foreign exchange contracts – cash flow hedges 38.0 1.0

Fuel hedging contracts – cash flow hedges 182.0 1.4

220.0 2.4

Non-current assets





64.0 6.6

Current liabilities



6.6 57.1

Non-current liabilities


Fuel hedging contracts – cash flow hedges – 1.1

0.2 6.4

Virgin uses derivatives to hedge its foreign currency through forward foreign

exchange contracts, fuel prices, interest rate risk exposure through interest rate

swap contracts and specific asset purchases denominated in foreign currencies. This

is to offset the volatility of changes in the fair value of cash flows of the hedged items

in the foreign exchange and commodities market. Regarding fuel hedging, the group

operated at a gain of $82.9 million in 2018, to be settled in the 2019 financial year.

This is not always a benefit, but in 2017 it had a loss of $10.9 million. The group

does not allow or take part in hedging for speculative trading purposes and only for

market risk management. Hedging strategies can provide protection from a sudden

and significant increase in jet fuel prices; however, they do not eliminate the

disadvantage if the price falls.



The tiered hedging policy introduced in 2011 was especially for fuel costs and aimed

to provide a greater certainty in the short term, while maintaining flexibility in the long

term.



15.5 Conclusion

Virgin Australia is a rapidly growing business that caters for domestic and

international aircraft passenger and freight services. It has sourced equity and debt

finance to enable the carrier to position itself as a major competitor in a difficult and

volatile marketplace. Virgin management have sought to provide solid benefits to

Virgin Australia’s major shareholders through strategic alliances, substantial benefits

to its employees and a valued service to its customers. It has made significant

contributions to the community and taken a responsible approach to the environment

worldwide. Management’s vision for the future has been materialised in strategic

planning through the Game Change program and the Better Business program. It

has undertaken significant investment in both physical assets and development of its

workforce. Virgin Australia has achieved strong improvements through the Better

Business program such as decreased costs, increased cash flow and improving the

capital position of the group. It has further consolidated its Australian domestic

aviation market segment and leveraged international opportunities, especially in the

Asian growth market, as well as investing in the Velocity business in order to drive

further growth.

Virgin’s vision is to become the sustainability leader within the aviation industry.

Major aviation-based shareholders support Virgin and provide each other with

substantial alliances for future growth. Virgin is in a very good position to capitalise

on market recovery.



Chapter questions

Multiple-choice questions

1 Virgin Australia's future growth is directed towards:

a the United States

b Europe

c New Zealand

d Asia

2 The prime function of Virgin Australia is as:

a A domestic carrier

b An international carrier

c A local and international carrier

d A freight carrier

3 Virgin Australia’s financial objectives include:

a Short-term growth and maintaining current profitability

b Long-term growth, future profitability and liquidity

c The elimination of unnecessary expenses and maintaining current

profitability

d Improving current liquidity and short-term growth

4 Virgin's Better Business program aims to improve:

a Future growth

b Operations

c Liquidity

d Budgets



5 Virgin Australia’s financial management strategy has:

a Not as yet returned a statutory profit

b Improved operations

c Improved liquidity

d Improved budgets

Short-answer questions

1 Identify the main ways that Virgin Australia plans to remain efficient in the short

term.

2 What is Virgin Australia’s legal structure?

3 Identify the four main global market influences that potentially affect Virgin

Australia.

4 How can the Velocity Frequent Flyers program provide revenue for the Virgin

Group?

5 Identify the financial risks that Virgin Australia could face through global financial

transactions.

Extended-response question

Analyse the methods and the sources of finance used by Virgin Australia to expand

globally.

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