Airweave financial analysis

Airweave financial analysis

Financial analysis outline

• Introduction
• Capital Structure
• Financial Statement Background
• Trend Analysis
• Cross Sectional Analysis
• Financial Instrument risk information
• Conclusion
• Recommendation
• Bibliography

Introduction

This article is about the financial analysis of Airweave. Airweave has been selling their core product, mattress pad since 2007. We examine the capital structure of Airweave using Modigliani-Miller theory. We analyse the financial trend of Airweave. We analyse and compare the financial statement of Airweave with other companies in the industry group. The financial instrument risk information will be discussed. Financial instruments are the borrowings and equity that Airweave uses to manage its financing. A conclusion will be made based on the analysis. Lastly, a few recommendations that may be useful for Airweave to manage its financial risks, will be discussed.

Capital Structure

We can use financial theory to explain the optimal debt ratio.

The Modigliani-Miller theorem with taxes, proposition one says that the value of levered firm is equal to the value of the unlevered firm, plus the tax multiplied by debt taken. Since debt borrowings are tax deductible, there are advantages of taking up debt. Leverage adds value to a levered company.

V_L = V_U + T*D ----- 1.1

where

V_L is the value of levered company

V_U is the value of unlevered company

D is the amount of debt taken

T is tax rate

The formula above says when we add debt to a company, the value of the company increases.

The Modigliani-Miller theorem with taxes, proposition two states that the cost of equity rises with leverage.

r_E = r₀ + D/E(r₀-r_d)(1-T) ----- 1.2

where

r₀ is the cost of equity without leverage

T is tax rate

r_d is the cost of debt

The formula says when we use more debt to replace equity, the WACC drops and there is an optimal capital structure.

For the optimal capital structure, we can refer to the table below. Firstly, we follow the Modigliani-Miller theory, and say that if the company takes on debt beyond the optimal level, the company will have greater default risk, so its cost of equity goes up, and its cost of debt also goes up. From the table, we find out that the lowest weighted average cost of capital (WACC) happens when D/E is equal to one.

To calculate WACC, we use the WACC formula as shown below:

WACC = Re*E/(D+E) + Rd*(1-T)*D/(D+E) ----- 1.3

According to the table below, the optimal D/E ratio for lowest WACC is when debt is roughly equal to equity.

Table 1: Optimal D/E ratio for lowest WACC

D/(D+E)	Re	Rd	After-tax Cost of Debt	WACC
0	10.50%	8%	4.80%	10.50%
10%	11%	8.50%	5.10%	10.41%
20%	11.60%	9.00%	5.40%	10.36%
30%	12.30%	9.00%	5.40%	10.23%
40%	13.10%	9.50%	5.70%	10.14%
50%	14%	10.50%	6.30%	10.15%
60%	15%	12%	7.20%	10.32%
70%	16.10%	13.50%	8.10%	10.50%

In 2016, the Airweave ratio of total liabilities to total equity is roughly one, which mean D/E is equal to one. So Airweave is close to its optimal capital structure.

For long term, and short term borrowing, the Japanese long term interest rate is at historic low at the moment. There is a risk of interest rate goes up in the next five years during to possible monetary tightening policy of the Bank of Japan. Therefore, Airweave takes advantage of the low interest rate situation by borrowing long term, and locking in lower rates.

Financial Statement Background

From the income statement below, the cost of goods sold is around 50% of its revenue in 2015, and 40% of its revenue in 2016, due to improving economies of scale. The selling and administrative expenses is slowly increasing due to company expansion. For income tax expenses, the corporate tax rate is about 40% in Japan from 2014 to 2016. Airweave pays 10% of its long term borrowing as the finance cost. The depreciation expenses is calculated from the balance sheet.

Items	Yearly/2016	Yearly/2015	Yearly/2014
	(31/12/2016)	(31/12/2015)	(31/12/2014)
	million yen	million yen	million yen
Income Statement
TOTAL REVENUES	14000	12000	9500
COST OF GOODS SOLD	5500	6000	4500
SELLING AND ADMINISTRATIVE EXPENSES	2200	1610	1250
DEPRECIATION EXPENSES	200	200	200
OTHER EXPENSES	90	90	90
TOTAL EXPENSES	7990	7900	6040
PROFIT (LOSS) BEFORE FINANCE COSTS AND INCOME TAX EXPENSES	6010	4100	3460
FINANCE COSTS	323	233	114
INCOME TAX EXPENSES	2275	1547	1338
NET PROFIT (LOSS)	3412	2320	2008
Other Comprehensive Income Statement
NET PROFIT (LOSS)	3412	2320	2008
EXCHANGE DIFFERENCES ON TRANSLATING FOREIGN OPERATIONS	192	76	-38
TOTAL OTHER COMPREHENSIVE INCOME	3604	2396	1970
DIVIDENDS	200	200	200

From the balance sheet below, the cash and cash equivalent number in 2015 and 2016 are calculated from cash flow statement. The property, plant and equipment, it is increasing because of Airweave company expansion. Similarly, the long term borrowings are increasing because Airweave borrows capital for expansion.

We can see that the ordinary shares and paid up capital are constant. The retained earnings keeps increasing from 2014 to 2016 because of strong financial performance of Airweave. As a result, the total equity of the company increase by 44% from 2014 to 2015, and 47% from 2015 to 2016.

Items	Yearly/2016	Yearly/2015	Yearly/2014
	(31/12/2016)	(31/12/2015)	(31/12/2014)
	million yen	million yen	million yen
CASH AND CASH EQUIVALENTS	4327	3924	2110
ACCOUNTS RECEIVABLE	3942	3117	2783
INVENTORIES	3433	4389	3468
PREPAID EXPENSES	458	453	367
SHORT TERM INVESTMENTS	434	636	424
OTHER CURRENT ASSETS	624	765	536
TOTAL CURRENT ASSETS	13218	13284	9688
INVESTMENT PROPERTIES	1921	1821	1221
PROPERTY, PLANT AND EQUIPMENTS	6023	3951	1832
Less: Accumulated Depreciation	600	400	200
INTANGIBLE ASSETS	167	167	167
Less: Accumulated Amortization	29	23	17
DEFERRED TAX ASSETS	428	453	367
OTHER NON-CURRENT ASSETS	87	52	13
TOTAL NON-CURRENT ASSETS	9255	6867	3817
TOTAL ASSETS	22473	20151	13505
BANK OVERDRAFTS	300	200	100
ACCOUNTS PAYABLE	1121	2122	1343
CURRENT PORTION OF LONG-TERM LIABILITIES	230	230	230
ACCRUED EXPENSE	1522	2122	1733
OTHER CURRENT LIABILITIES	553	213	121
TOTAL CURRENT LIABILITIES	3726	4887	3527
LONG-TERM BORROWINGS FROM FINANCIAL INSTITUTIONS	3233	2333	1135
LIABILITIES FOR EMPLOYEE RETIREMENT BENEFITS	524	477	165
OTHER NON-CURRENT LIABILITIES	746	453	233
TOTAL NON-CURRENT LIABILITIES	8229	8150	5060
TOTAL LIABILITIES	11955	13037	8587
ORDINARY SHARES	4499	4499	4499
ISSUED AND FULLY PAID-UP SHARE CAPITAL	240	240	240
RETAINED EARNINGS	5460	2248	128
CURRENCY TRANSLATION CHANGES	319	127	51
TOTAL EQUITY	10518	7114	4918

From the cash flow statement below, for the cash from operating activities, the net profits numbers are calculated from income statement. The changes in account receivable, inventories, prepaid expenses, short term investments, other current assets, account payable, accrued expenses, other current liabilities, non current liabilities are from balance sheet.

For the cash from investing activities, the changes in investment properties, property plant and equipments are calculated from balance sheet. For the cash from financing activities, the changes in long term borrowings and retirement benefits are calculated from balance sheet.

Items	Yearly/2016	Yearly/2015	Yearly/2014
	(31/12/2016)	(31/12/2015)	(31/12/2014)
	million yen	million yen	million yen
NET PROFIT	3412	2320	2008
DEPRECIATION	-200	-200	-200
AMORTISATION	-6	-6	-6
CHANGES IN ACCOUNT RECEIVABLE	-825	-334	-321
CHANGES IN INVENTORIES	956	-921	-345
CHANGES IN PREPAID EXPENSES	-5	-86	-50
CHANGES IN SHORT TERM INVESTMENTS	202	-212	45
CHANGES IN OTHER CURRENT ASSETS	141	-229	-100
CHANGES IN ACCOUNT PAYABLE	-1001	779	343
CHANGES IN ACCRUED EXPENSES	-600	389	212
CHANGES IN OTHER CURRENT LIABILITIES	340	92	46
CHANGES IN OTHER NON-CURRENT LIABILITIES	293	220	101
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES	2707	1812	1733
CHANGES IN INVESTMENT PROPERTIES	-100	-600	-100
CHANGES IN PROPERTY, PLANT AND EQUIPMENTS	-2072	-2119	-212
CHANGES IN INTANGIBLE ASSETS	0	0	0
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES	-2172	-2719	-312
CHANGES IN LONG-TERM BORROWINGS FROM FINANCIAL INSTITUTIONS	900	1198	500
CHANGES IN LIABILITIES FOR EMPLOYEE RETIREMENT BENEFITS	47	312	93
DIVIDEND PAID	-200	-200	-200
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES	747	1310	393
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENT	1282	403	1814
CASH AND CASH EQUIVALENTS, BEGINNING BALANCE	4327	3924	2110
CASH AND CASH EQUIVALENTS, ENDING BALANCE	5609	4327	3924

Trend Analysis

We analyse the Airweave financial data from year 2014 to year 2016.

The company has about the same liabilities and equities in 2016 due to increased borrowings from the bank for company expansion. The Account Receivables is slowly increasing, and Property Plant and Equipments (PP&E) increases significantly over the three years due to increase in fixed assets investment.

Table 2: Airweave overall cash flow analysis

Cash flow analysis Unit:Million yen

Item	2016	2015	2014
Net Cash flow from operating activities	2,207	1,812	1,733
Net Cash flow from investing activities	(2,172)	(2,719)	(312)
Net Cash flow from financing activities	747	1,310	393
Net change in cash	1,282	403	1,814

Table 3: Airweave cash flow analysis showing sources and uses of cash

	2016	2015	2014
Revenue	14,000	12,000	9,500
Net Income	3,412	2,320	2,008
Account Receivable	(825)	(334)	(321)
Inventories	956	(921)	(345)
Account Payable	(1,001)	779	1,343
Accrued Expenses	(600)	389	212
Capital Expenditures	(2,072)	(2,119)	(212)
Common Dividends	(200)	(200)	(200)
Long Term Borrowings	900	1198	500

For cash flow from operations, the major source of cash are net income, and increase in Account Payables for year 2014 ad 2015. The major use of cash are Inventories for year 2014 and 2015, Account Receivables from year 2014 to 2016. The Account Payable is a source of cash in 2014 and 2015, and a use of cash in 2016. The Accrued Expenses is a source of cash in 2014 and 2015, and a use of cash in 2016. The cash flow from operations is a positive number and increases from 2014 to 2016.

For cash flow from investing, the major use of cash is purchase of PP&E or capital expenditures. It was used in new shops and capacity expansion. The cash flow from investing is a negative number and highest negative value in 2015.

For cash flow from financing, in 2014 and 2015 and 2016, the major source of cash was an increase in long term borrowings. In all three years, the major use of financing cash flow is the dividends paid. The cash flow from financing is a positive number and has highest positive value in 2015.

In the overall, the net change in cash is positive from 2014 to 2016.

DuPont Analysis

DuPont analysis is useful to measure the financial performance of a company. This analysis method was started by the DuPont Corporation in 1920s. It measures return on assets (ROA) and return on equity (ROE). ROE is the net income as a percentage of total shareholder equity. ROA is the net income as a percentage of total assets. According to DuPont analysis, ROA is broken down into two parts, and ROE is broken down into three parts. The details are shown below.

ROA = NI/Sales * Sales/total Assets

ROE = NI/Sales * Sales/total Assets * Total Assets/Total SH Equity

DuPont Analysis is useful to determine what is driving the company’s financial performance. Profit Margin shows the operation efficient. Asset Turnover shows the asset usage efficiency. The financial leverage shows the degree of leverage of the company.

Table 4: NI/Sales (Profit Margin)

2016	2015	2014
0.2437	0.1933	0.2114

Table 5: Sales/total Assets (Asset Turnover)

2016	2015	2014
0.6229	0.5955	0.7034

Now, we have Profit margin and Asset turnover. We multiply them and obtain the ROA number.

Table 6: ROA calculation

Item	2016	2015	2014
ROA	0.2437*0.6229 =0.1518	0.1933*0.5955 =0.1151	0.2144*0.7034 =0.1508

The Net profit margin is declining from 2014 to 2015, and increases from 2015 to 2016.

The Asset Turnover declines from 2014 to 2015, then increases from 2015 to 2016.

In the overall, ROA declines from 2014 to 2015, and increase from 2015 to 2016. It is a good indicator of company performance.

Table 7: Total Assets/Total SH Equity (Financial Leverage)

2016	2015	2014
2.1367	2.8325	2.7460

Now, we multiply Profit margin, Asset Turnover and financial leverage, we obtain the ROE number.

Table 8: ROE calculation

Item	2016	2015	2014
ROE	0.2437*0.6229*2.137 =0.3244	0.1933*0.5955*2.833 =0.3261	0.2144*0.7034*2.746 =0.4141

The Net profit margin is declining from 2014 to 2015, and increases from 2015 to 2016.

The Asset Turnover declines from 2014 to 2015, then increases from 2015 to 2016.

The equity multiplier increases from 2014 to 2015, then decline in 2016.

In the overall, ROE declines from 2014 to 2016. The decline in 2016 is due to less financial leverage. ROE decline is an indicator that the company is using more equity to generate net income. The more equity comes from increased retained earnings. This is a good sign.

The conclusion of DuPont analysis : Airweave profitability performance is improving from 2014 to 2016. For every Japanese yen that the investors put into AIrweave assets, the return that investors get out of it, is increasing.

Cross Sectional Analysis

Cross sectional analysis is a comparison of company financial performance against industry peers, within the industry group. The purpose is to find out the financial performance of Airweave relative to its industry peers. Airweave is a mattress and mattress pad company. It is not possible to find listed Japanese company that manufactures mattress or mattress pad in the Tokyo Stock Exchange or other stock exchange in Japan. We use Japanese hospital bed manufacturer, Paramount Bed, Dutch mattress and bedroom furniture company, Beter Bed and American bed and mattress company, Sleep Number, as the industry peers. Only one of these companies is located in Japan. The other two companies are not located in Japan but they are mattress company. So we use them for comparison.

Firstly, we will see the fiscal year end of the companies. Their fiscal year end is shown in table below.

Table 9: Fiscal year end of companies

Airweave	Paramount Bed	Sleep Number	Beter Bed
31 December	31 March	31 December	31 December

Next, we find out and compare the financial ratios of the four companies in year 2016. For the easy understanding of the readers, we explain the financial ratios used in the analysis.

Firstly, there is the Liquidity ratio. It is a measure of the company’s ability to pay debt obligations.

Current ratio = Current Assets / Current Liabilities

Quick ratio = (Cash and equivalents + Marketable securities + Accounts receivable) / Current Liabilities

Current ratio measures the company’s ability to pay short term and long term debt. Quick ratio is an indicator of company’s short term liquidity.

Secondly, there is Asset Management ratio. It measures company’s ability to use assets to generate sales.

Inventory Turnover = Sales / Average Inventory

Asset Turnover = Sales / Total Assets

Fixed Asset Turnover = Sales / Fixed Assets

Inventory Turnover measures the company’s management of its inventory. Asset Turnover measures the company’s management of its assets. Fixed Asset Turnover measures the company’s management of its fixed assets

Thirdly, there is Debt Management ratio. It measures the company’s resources coming from debt or from equity. It measures the company’s financial leverage.

Debt ratio = Total Debt / Total Assets

Debt/Equity ratio = Total Debt / Total Assets

Debt ratio measures the level of debt of a company. Debt/Equity ratio measures the degree of leverage of a company. It shows how much debt the company use to finance its assets relative to the amount in equity.

Fourthly, there is Profitability ratio. It measures the business profit compared to its expenses and cost.

Gross Margin = Gross Profit / Revenue

Operating Margin = Operating Profit / Revenue

Net Margin = Net Profit / Revenue

ROA = Net Profit / Total Assets

ROE = Net Profit / Total Equity

The gross margin measures the profitability before operating factors is considered. The operating margin measures the profitability after operating efficiency is considered. The net margin measures the profitability after tax and interest payments are calculated. The ROA and ROE are described in details in DuPont analysis section.

Lastly, there is receivable turnover and payable turnover.

receivable turnover = sales/account receivable

payable turnover = sales/account payable

High numbers in receivable turnover means fast cash recovery, fast cash collection time.

Low numbers in payable turnover means company pays suppliers slowly.

Table 10: Cross sectional analysis

Item	Airweave	Paramount	Sleep Number	Beter Bed	Average
Liquidity ratio
Current Ratio (x)	3.55	3.51	0.61	1.50	2.29
Quick Ratio (x)	2.34	2.98	0.14	0.54	1.50
Asset Management Ratio
Inventory Turnover (x)	4.08	10.19	17.48	6.63	9.59
Asset Turnover (x)	0.62	0.59	2.87	2.86	1.74
Fixed Assets Turnover (x)	2.32	2.46	6.29	8.74	4.95
Debt Management Ratio
Debt Ratio(x)	0.53	0.33	0.65	0.46	0.49
Debt/Equity ratio(x)	1.14	0.48	1.85	0.87	1.08
Profitability Ratio
Gross Margin %	60.71	42.64	61.78	57.76	55.72
Operating Margin %	42.93	13.04	5.85	6.34	17.04
Net Profit Margin %	24.37	8.62	3.92	4.63	10.38
ROA %	15.18	5.06	11.25	13.24	11.18
ROE %	32.44	7.49	32.07	24.73	24.18
Receivable and Payable Turnover Ratio
Receivables Turnover(x)	3.55	3.01	66.55	31.59	26.17
Payable Turnover (x)	12.49	5.69	12.44	12.88	10.87

As can be seen from the table above, we compare the liquidity ratio, asset management ratio, debt management ratio and profitability ratio, and receivable payable turnover ratio.

For easy understanding, the above table is plotted in the graphs below.

Figure 1: Liquidity ratio

Figure 2: Asset Management ratio

Figure 3: Debt Management ratio

Figure 4: Profitability ratio

Firstly, the liquidity ratio, Airweave current ratio is above industry average, and the quick ratio is above industry average too. For the liquidity ratio, the higher the number, the better it is. So Airweave is in good position in terms of liquidity ratio.

Secondly, the asset management ratio, Airweave’s Inventory Turnover, Asset Turnover and Fixed Assets Turnover are below industry average. For the asset management ratio, the higher the number, the better it is. The implication is that Airweave is not generating high enough sales from the existing assets and inventories. Airweave is using more assets to generate sales, compared to its industry average. There is room for improvement in asset management for Airweave. Airweave could improve its asset management strategy.

Thirdly, the debt management ratio, Airweave debt ratio and debt/equity ratio are slightly higher than industry average. Airweave is using more borrowings compared to its industry average. However, Airweave is a young and growth company. It is using leverage to grow its business and generate sales. Its debt/equity ratio is close to one, which is the optimal case for capital structure. Therefore, it is acceptable for a company such as Airweave to borrow up to 50% of its assets because it uses the borrowings to maximise the value of the company.

Fourthly, profitability ratio, the Airweave numbers beat the industry average in every cases. For the profitability ratio, the higher the number, the better it is. It shows that Airweave is well managed, with little operating and administration overhead. It could be because Airweave is a small and tightly run company. Airweave has less overhead and it can achieve a high profitability ratio.

Lastly, the receivable and payable turnover ratio is discussed. The receivable ratio measures the efficiency of company collecting credit sales from customers. The ratio is the higher the number, the better it is. Airweave has the lowest receivable turnover ratio. The payable turnover ratio is the ratio that measures the efficiency of company paying credit sales to suppliers. The ratio is the lower the number, the better it is. Airweave has the highest payable turnover ratio. Airweave is collecting receivables too slow and paying payables too fast.

Furthermore, for further understanding of company performance, we calculate the net operating cycle. Net operating cycle shows how many days it takes to create inventory, sell inventory, and collect money from customers. The lower the number, the better is the company performance.

Net operating cycle = No. of Days of Inventory + No. of Days of Receivables - No. of Days of Payables

Table 11: Net operating cycle comparison of the four companies in year 2016

	Airweave	Paramount	Sleep Number	Beter Bed
No. of Days of Inventory	89.46	35.82	20.88	55.05
No. of Days of Receivables	102.82	121.26	5.48	11.55
No. of Days of Payables	29.22	64.15	29.34	28.34
Net Operating Cycle	163.06	92.93	-2.98	38.26

Airweave has the highest Net operating cycle. So it is below the performance of industry peers.

Next, we look at the cash flow of the four companies in year 2016. We will attempt to get a clearer picture of the financial health of the companies from the cash flow analysis.

For USD, we use exchange rate of JPY/USD of 115.

For Euro, we use exchange rate of JPY/EUR of 121.

Table 12: Cash flow comparison of the four companies in year 2016

Unit:Million yen

Item	Airweave	Paramount	Sleep Number	Beter Bed
Net Cash flow from operating activities	2707	9657	17439	4119
Net Cash flow from investing activities	(2172)	(2038)	(4907)	(2391)
Net Cash flow from financing activities	747	(5493)	(13610)	(2178)
Net change in cash	1282	2126	(1078)	(450)

From the table above, we can see that Airweave operating cash flow sizes are smaller than other other three companies. This is expected as Airweave is a smaller company in terms of operation size, and sales. It can be seen that Airweave has a strong positive net change in cash given its smaller net cash flow from operations. Its has an investing cash flow which is almost equal to the cash flow from operations. It is also getting a positive financing cash flows.

Breakeven Point Analysis

The analysis is to find out the minimum number of units required to overcome the variable cost and fixed cost of the company’s operation. A graph illustrating the break even analysis is shown below.

Figure 5: Breakeven analysis

Source: http://www.12manage.com/methods_break-even_point.html

In 2016, the sales is 14000 million yen. The Airweave mattress pad selling price ranges from 50000 yen to 250000 yen. Taking the middle figure of 150000 yen, 14000 million is divided by 150000, the result is 93333 unit sales. Airweave cost of goods sold is 5500 million yen. The 5500 million is divided by by 93333 unit, the result is 58928 yen. This number is the variable cost per unit sold. For the fixed cost, it can be found by adding up the selling and administrative expenses, depreciation expenses, and other expenses. The result is 2490 million yen which is the fixed cost.

To show the calculation:

14000 million / 150000 = 93333 unit (sales)

5500 million / 93333 = 58928 yen (variable cost)

To break even, we can use a formula to calculate. Assuming unit is the number of units to breakeven:

150000 * unit = 2490 million + 58928 * unit

Unit = 27341

Therefore, we can see that 27341 units are needed for the company to break even. The company is selling 93333 units in 2016. It has exceeded the break even point.

Financial instrument risk information

Financial instrument risk is the risk of using the financial instrument in a company’s operation. In Airweave case, it uses long term borrowings, and equity from green tea company to fund its investment. Airweave has roughly one to one of debt to equity ratio in 2016. From the capital structure, Airweave financial instrument (debt, equity) is subject to market risk, such as interest rate risk, currency risk, price risk.

To measure the market risk, we can use Value at risk (VaR) method. Value at risk measures the probability that financial instrument of a firm will lose a certain amount in a given period of time. For example, we can say: with 95% confidence, we expect the investment will not lose $10 million yen over a year.

There are three methods to calculate VaR. There are historical method, variance covariance method, and Monte Carlo method.

The VaR formula is: VaR = R_p - Z * σ_p

Z is the value of test statistics, it can be of 95% or 99% confidence level.

95%: 1.65

99%: 2.33

For the Airweave debt borrowing, Airweave takes up fixed rate borrowings at low interest rates, so there is very little market risk.

For the Airweave equity, it is subject to currency risk. Airweave equity valuation will decline when its domestic currency appreciates.

To show an example of the application of VaR formula: If return of equity is set at 10%, the standard deviation of return is 10%, at 95% confidence level, the VaR is:

VaR = 0.10 - 1.65*0.10 = -0.065

In 2016, the total shareholder equity capital is 10518 million yen. We multiply 0.065 by 10518 million, the result is 683 million. In this example, the minimum equity capital at risk, or losses, would be 683 million, at 95% confidence level.

Conclusion

Airweave is a growth company. Its total revenue is growing. Its retained earnings is increasing in the three year period from 2014 to 2016. Its net cash flows are positive in the three year period from 2014 to 2016. It has a strong balance sheet, such as strong current ratio, quick ratio, reasonable D/E ratio, and high ROE and ROA and high profit margin. All these numbers show that it is in good financial position.

The negative with Airweave is the asset management ratio. Airweave’s asset management ratio is below its peers. Airweave should improve on asset management, in the way that it should use less assets to generate sales. With expected revenue growth in the coming years, Airweave is expected to continue with its strong financial position.

Furthermore, Airweave has the worst net operating cycle. Airweave should improve on this aspect. Airweave can shorten the number of days in inventory, number of days in receivables.

After three years, when Airweave is listed on the Tokyo Stock Exchange, their financial statements will be available for public viewing. It will help to validate our assumptions in the financial statements.

Recommendation

Airweave is preparing to be listed on Tokyo Stock Exchange before the Tokyo Olympics in year 2020. Airweave is aggressively expanding overseas so it is subject to more currency risk. On a sales revenue of 14000 million, if 30% are from overseas, 4200 million is at risk of exchange rate changes.

To reduce finance risk of Airweave, we propose the following strategies as written below. The strategies make use of derivatives, such as as FX futures, FX forward, FX swap, and swaption. The details of the derivatives are described in the points below.

1. Use FX futures contract or FX forward contract to hedge the earnings coming from outside Japan, managing the currency risk. FX future is a publicly traded future contract, it is standardised and free of counterparty risk. Counterparty in this case is the exchange. FX forward is a privately negotiated contract between one company and one financial institution. It can be customised and subject to counterparty risk. Both FX future and FX forward are used to lock in the exchange rate in the future.
2. It can also use FX swap to manage the currency risk. FX swap is a privately negotiated contract between one company and one financial institution, to exchange one currency for another currency.

For item one and two, we can further analyze. Firstly, we see the domestic currency return is made up of:

Rdc = (1+Rfc)(1+Rfx)-1

Where

Rfx = Return of foreign exchange rate

Rfc = Return of foreign currency

And the variance of return σ_dc² = σ_Fc² + σ_FX² + 2 σ_Fcσ_Fx COV(FC, FX)

We can hedge foreign currency return, be it USD or SGD or HKD, and convert them to yen.

For example, we can see from table 12 below about how to make hedging decision.

Table 12: Hedging foreign currency

	Current spot rate	six month forward rate	six month forecast spot rate
JPY/USD	113.4	116.4	112.6

Airweave is long the USD against JPY, and JPY/USD is selling at a forward premium. Moreover, Airweave expects USD to depreciate against the JPY. This is a case of hedging the USD exposure.

To find the optimal the minimum variance hedge ratio, (the optimal hedging ratio) we can use the formula:

Hedge ratio = correlation(FC, FX)*σ_Fc/σ_FX

For example, if the hedge ratio is 2.3, for a USD 1 million exposure, Airweave will need short a JPY/USD forward contract of USD 2.3 million.

3. Manage the interest rate risk, Airweave borrows in fixed interest rate. If interest rate goes down, Airweave will suffer a loss. Airweave can buy a swaption on pay floating, receive fixed swap, Airweave can exercise it if necessary. Swaption is an option to enter into an swap.
4. Implement an action plan to accelerate collecting account receivables from customers, so that it can increase its receivables turnover.
5. Implement an action plan to delay paying payables to suppliers, so that it can reduce its payable turnover.

Bibliography

Academic Paper:

[1] Foerster, S., Tsagarelis, J., Wang, G., Are Cash Flows Better Stock Return Predictors Than Profits? Financial Analysts Journal, First Quarter 2017, Vol. 73, No. 1: 73–99. Retrieved Feb 25, 2017, from http://www.cfapubs.org/doi/abs/10.2469/faj.v73.n1.2

[2] Ahmet, F., Prenaj B., A CRITICAL REVIEW OF MODIGLIANI AND MILLER’S

THEOREM OF CAPITAL STRUCTURE, International Journal of Economics, Commerce and Management, June 2015.

http://ijecm.co.uk/wp-content/uploads/2015/06/3657.pdf

[3] Faccio, M., Xu, J., Taxes and Capital Structure, Volume 50, Issue 3 June 2015, pp. 277-300. Retrieved Feb 25, 2017, https://papers.ssrn.com/sol3/papers2.cfm?abstract_id=1781158

[4] Costea, C., Hostiuc, F., THE LIQUIDITY RATIOS AND THEIR SIGNIFICANCE IN THE FINANCIAL EQUILIBRIUM OF THE FIRMS, The Annals of The "Ştefan cel Mare" University Suceava, 2009.

http://www.seap.usv.ro/annals/ojs/index.php/annals/article/viewFile/176/182

[5] Glickman, M., Modigliani-Miller On Capital Structure: A Post-Keynesian Critique, Fourth International Conference of the International Trade and Finance Association, 1994.

ftp://ftp.repec.org/opt/ReDIF/RePEc/wuk/elecwp/elecwp9608.pdf

Textbook:

[6[ Brigham. E., Houston. J., Essentials of Financial Management 3rd Edition, 2014.

Websites:

[7] Yen surge 'extremely worrying' warns Japan's finance minister, Retrieved Feb 27, 2017, http://www.telegraph.co.uk/business/2016/05/01/yen-surge-extremely-worrying-warns-japans-finance-minister/

[8] An Introduction to Value at Risk, Retrieved April 17, 2017, http://www.investopedia.com/articles/04/092904.asp

[9]      DuPont Analysis Definition, Retrieved April 17, 2017,

http://www.investinganswers.com/financial-dictionary/ratio-analysis/dupont-analysis-3123

[10] Value of Export and Imports of Japan, Retrieved Feb 27, 2017, http://www.customs.go.jp/toukei/shinbun/trade-st_e/2016/2016_316e.pdf