Introduction
This paper explores the costing and pricing methods applicable to firms in the tourism and travel sector using Allegiant Travel Company as an example. Allegiant Travel Company is an American company providing leisure travel products and services to under-served cities in the US. It provides air transport, air transport-related products, travel protection products, hotel rooms and other third party travel products. The paper also analyses the financial statements to assess its financial state.
Costing methods
Several costing methods can be applied in the tourism industry depending on the nature of the assignment and the operations of the organization. Applicable costing methods include job order costing, batch costing, process costing, and multiple costing, among other methods.
Job order costing: This is used when the tourism organization receives distinct orders from clients. The specifications vary from each order to another. In this case, costs are allocated and accumulated for the each order or project (Drury, 2012). This helps the organization in determining the total cost of the order as well as the appropriate price and profit on each order. In the tourism industry, each client may require different services or specifications. Job order costing helps in determining the cost for each customer or order. Each client’s order for air transport services at Allegiant Travel Company is distinct and depends on the destination of the client.
Batch costing: A firm in the tourism industry can apply batch costing if it receives several small but identical orders (Drury, 2012). For instance, if a number of tourists order for a similar product, the cost of the product can be allocated to the entire batch. The cost for each order is determined by dividing the total cost for the batch by the number of identical orders. The use of this costing method is limited in the tourism industry since most products and services are not identical. Clients usually have different demands. Allegiant Travel Company can use this method if many people seek similar air transport services to the same destination and similar hotel room services. It can determine the total cost for all clients then divide by the number of clients to determine the cost for each product.
Multiple costing: some products and services in the tourism industry exhibit several features that make the application of a single costing method difficult. Therefore, a firm in the tourism industry can use a combination of several costing methods.
Cost, volume and profit analysis
Tourism organizations can also apply the concept of cost-volume and profit in decision making. This concept helps in determining the relationship between the cost, volume, and profit of a product or service. One key concept, in this case, is the break-even analysis. Allegiant Travel Company can use break-even analysis to determine the occupancy it requires to cover its total costs of providing accommodation services. The company can also use this concept to determine the number of passengers it requires for it to cover the total cost of providing air transport to clients. It also helps in determining the average daily rate required to earn the desired profit. Besides, it can use the concept to determine the effect of changing the price or investing in advertising on the profitability of the firm. It also used in organizations with multiple products and services to identify which ones to emphasise. CVP analysis can be used to assess the profitability of each product or service and to determine the most suitable mix.
Pricing strategies in the travel and tourism sector
Cost-plus pricing: This pricing method is based on the cost of the product or service (Drury, 2012). The company determines the cost of the product or service then adds the desired profit margin to find its price. This strategy enables the firm to recover the cost of production and guarantee a profit.
Competition based pricing: This strategy involves using the competitors’ price as a basis for determining the price of a product or service. The firm may decide to charge the same price, a lower or higher price depending on its competitive position in the market.
Penetration pricing: This strategy is used by a firm to gain market share in a market where competitors are already operating. It involves charging a lower price than that of competitors.
Role of management accounting information in decision-making
Managerial decision making can be sub-divided into planning decisions and control decisions. Management accounting information plays a critical role in these types of managerial decisions (Drury, 2012). Management accounting provides valuable historical data to assist in planning. For instance, the preparation of budgets requires detailed data from each functional unit of an organization. Besides, management accounting information provides past data that can be used as benchmarks.
It also provides data for assessing specific managerial plans such as the decision to accept or reject an offer from a customer, make versus buy, among other decisions (Drury, 2012). The information provided is used in determining the incremental impact of these decisions on the overall profitability of the organization. Thus, it helps the management to choose the most suitable option.
Management accounting information is also used in evaluating capital projects. It provides data on the expected costs of an investment and the estimated cash flows. Capital budgeting techniques are then applied to assess the viability of each capital project alternative. Besides, the decision to close a business plant or unit relies on management accounting information to assess the overall impact on the profitability of the organization. It helps in identifying all the incremental costs and revenues.
Management accounting information is also essential in control decisions. Control decisions involve comparing the planned and actual performances and taking corrective actions when necessary. The information assists in developing standards or benchmarks upon which actual performance can be evaluated. For instance, Allegiant Travel Company can develop standard costs for a particular trip using past data. The actual costs of the trip can be determined during or after the trip to identify any variances (Drury, 2012). Management accounting can also help the company to analyse the variances to determine the possible causes and recommend corrective actions to avoid such variances in future trips.
Therefore, management accounting enhances decision making in organizations by providing relevant and detailed information. Such information enables the management of the organisation to assess every aspect of the decision or factors under consideration. Decisions in any organization are sound if they are based on data. Besides, management accounting information is detailed unlike financial accounting information hence it facilitates managerial decision making.
Objectives and importance of a budget
Budgets assists in planning and providing direction to the organization. It assists the organization in quantifying its plans and identify the activities required to meet its objectives as well as the costs of each activity. For instance, if Allegiant Travel Company wants to expand its market by acquiring a new fleet of planes, a budget will help it to identify all the activities required to implement the planned expansion. Besides, the budget will provide information on the costs of each of the activities involved in the process.
Besides, budgets are prepared to enhance control. It assists in establishing standards thus preventing wasteful use of resources in an organization. The budget for each functional unit indicates the maximum amount the functional unit is allowed to spend. Based on this amount, the functional manager can take measures to ensure that the department operates within the allocated budget.
Another objective of a budget is to assist in the allocation of resources to the various departments, functional units, products or services in the organization (Epstein and Lee, 2011). The budgeting process involves the preparation of functional budgets which are then submitted to the budget committee for approval. The budget committee reviews functional budgets and approves them based on resource availability and the overall objectives of the organization. The budget for each functional unit implies the amount of resources allocated to the functional unit in that period. Allegiant Travel Company can use budgets to allocate resources to air transportation, air-related ancillary products and services, and third party products and services.
Budgets are also prepared to assist in performance evaluation (Epstein and Lee, 2011). A budget is a standard or benchmark upon which the actual performance is assessed. It is prepared to assist the organization to determine whether it is on the right track in achieving its objectives.
Importance of a budget
A budget can help Allegiant Travel Company to improve the planning process by providing the details of each plan including their corresponding costs. It also assists in controlling costs by enabling the calculation and analysis of variances. Allegiant Travel Company can use a budget to determine whether there is a favourable or unfavourable variance in the cost of a trip and take corrective actions (Epstein and Lee, 2011). A budget also enhances coordination among different functional units of the company. For instance, the transportation budget will be based on the budgeted number of customers provided by the sales and marketing department. The budget aligns all the activities of the company’s functional units to the overall objectives of the company.
Liquidity analysis
The current ratio for Allegiant Travel Company as at December 31, 2015, was 1.107 indicating that it had adequate current assets to settle its short-term obligations. The ratio decreased from 1.479 in 2013 to 1.198 in 2014 and then to 1.017 in 2015. The trend shows a decline in Allegiant’s liquidity in 2014 and 2015. As at December 31, 2015, Allegiant’s quick ratio was 0.977 implying that its quick assets could repay about 97.7% of its total short-term obligations. Allegiant’s quick ratio was 1.412 in 2013 then declined to 1.151 in 2014 and 0.977 in 2015. These ratios indicate the Allegiant Travel Company can meet its short-term obligations since current assets are greater than current liabilities (Gibson, 2008). However, the trend shows that the liquidity of the firm has declined in each of the last two financial years.
Profitability analysis
In the year 2015, Allegiant Company had an operating margin of 29.45% implying that it made an operating income of $0.945 for every dollar of total revenue. This is positive and high thus its operations were profitable. The operating margin was 15.53% in 2013 but declined to 13.8% in 2014 then increased to 29.45% in 2015. This shows that Allegiant’s profitability improved in 2015.
The return on assets for Allegiant for 2015 was 16.3% showing that it earned a net income of $0.163 per dollar of total assets used in its operations during the year. The positive return on assets shows that Allegiant was profitable. The firm’s return on assets was 7.018% and 9.92% in 2014 and 2013 respectively. This trend suggests that the profitability of Allegiant improved in 2015.
Allegiant’s return on equity increased from 24.56% in 2013 to 29.60% and 62.96% in 2014 and 2015 respectively. The ratio implies that the company earned a net profit of $0.6296 from every dollar of total revenue it generated in 2015. The high return on equity indicates that Allegiant was profitable. Besides, the trend shows that Allegiant’s profitability increased in 2015.
Solvency analysis
Allegiant’s debt ratio as at December 31, 2015, was 0.741 implying that it financed 74% of its total assets through external financing. The debt ratio is high showing that it has a high leverage and a low solvency. Allegiant’s debt ratio increased from 0.596 in 2013 to 0.763 in 2014 indicating that the solvency of the travel agency declined in 2014. In 2015, it declined to 0.741 suggesting a slight improvement in the solvency of the firm.
Its debt-equity ratio as at December 31, 2015, was 2.862 showing that its total liabilities outweighed its total equity. The debt-equity ratio increased from 1.476 in 2013 to 3.217 in 2014 showing a significant decline in Allegiant’s solvency. The reduction in the ratio in 2015 indicates that Allegiant’s solvency improved in 2015.
Allegiant’s Times Interest Earned ratio for 2015 was 14.08 times meaning that it earned adequate earnings to cover its interest obligations. This shows that the interest cover is high thus the possibility of the firm defaulting its interest obligations is low. The ratio fell from 16.45 in 2013 to 7.467 indicating that the solvency declined. The increase in 2015 shows that the solvency of Allegiant increased in 2015.
Although Allegiant has a high leverage, it is financially stable. The interest cover is high hence it can meet its interest obligations. A high leverage may also be good for the shareholders since it increases the return on equity. The return on assets is positive hence an increase in debt causes an increase in the return on equity.
Efficiency analysis
Inventory turnover for 2015 was 45.12 implying that it replenished its inventory 45 times. This implies that the average inventory holding period was eight days. It increased from 35.79 in 2013 to 44.35 in 2014 and 45.12 in 2015. This indicates that Allegiant’s efficiency improved in both 2014 and 2015. Its receivables turnover was 83.33 in 2015, up from 55.50 in 2014 and 47.29 in 2013. This shows that it is efficient in collecting money from its debtors.
Investment ratios
Allegiant’s earnings per share was $4.87 and $4.85 in 2014 and 2013 respectively. Its cash dividend per share was $2.50 in 2014, up from $2.25 and $2.00 in 2013 and 2012 respectively. This shows that the company has consistently paid dividends hence it is a good investment stock.
Overall assessment of the financial condition
Analysis of the liquidity of Allegiant indicates that it has a strong liquidity although its liquidity fell in 2015. It is also profitable as shown by the profitability ratios and its profitability improved significantly in 2015. Solvency analysis shows that Allegiant has a high leverage since its debt capital is more than the equity capital. However, it generated adequate revenues to cover its interest obligations hence the possibility of default in interest payments is low. Efficiency ratios show that it is efficient in converting inventory into revenues as well as collecting receivables. Lastly, its investment ratios show that it offers a good return on investment. Therefore, Allegiant Travel Company is financially stable . Thus, I recommend investors to purchase its stock.
Allegiant Travel Company has two broad sources of finance required to finance its expansion plans; equity and debt.
Equity financing
Allegiant can raise more capital by issuing new shares either to the public or existing shareholders. The company’s stock is already trading at the NASDAQ exchange hence raising additional equity will be easy. The new equity can be issued through a rights issue, public issue or private placement. Under the rights issue, the company will offer additional stocks to its existing shareholders on a pro rata basis. For instance, it can give each shareholder two more shares for every three shares held. It can also offer the new shares to the public or private investors.
Advantages of equity financing
Allegiant Travel Company will not have to repay equity capital. The company does not have to repay the amount unlike in debt financing. Besides, equity capital is a permanent source of capital and can only be eliminated when Allegiant is winding up. Secondly, the Allegiant will not have any obligation to pay dividends (Moles, 2011). The payment of dividends is at the discretion of the directors of the company and is only done when the firm earns profits. Therefore, equity is less costly to maintain than debt which requires regular interest payments irrespective of the earnings of the corporation (Moles, 2011). Equity financing also improves the solvency of the company by reducing leverage. This enhances the firm’s access to other sources of finance such as borrowing.
Disadvantages of equity financing
Equity financing leads to the dilution of control of the company. The new shareholders will have a say in the management of the affairs of the company. Besides, they will share in the company’s dividends hence, the dividend per share will decline (Moles, 2011). Equity financing attracts double taxation since dividends are non-deductible, unlike interest payments which are allowable for taxation purposes (Moles, 2011). It is costly to raise equity capital since the flotation costs are high. Besides, there are lengthy procedures in issuing equity.
Debt financing
Allegiant can also raise capital for expansion by borrowing from banks and other institutions as well as issuing corporate bonds.
Advantages
It is cheaper to raise debt than equity since the floatation cost for equity is higher than that of debt. The company can access the debt capital within a short time since it does not require lengthy procedures like issuing equity securities. Debt reduces taxable income since interest on the debt is an allowable expense. On the contrary, dividends to shareholders are subjected to double taxation (Moles, 2011). It does not dilute control like equity financing since debt holders do not have voting rights and do not share in the dividends of the company.
Disadvantages
Debt financing increases leverage in the company thereby limiting its access to other sources of financing. Allegiant Travel Company already has a high leverage hence obtaining additional debt financing may be difficult (Moles, 2011). Besides, the lenders may require higher interest rates due to the high risk. Furthermore, interest on the debt is payable regularly irrespective of whether Allegiant makes profits or not. This is unlike equity financing where Allegiant will only pay dividends when it makes profits or deems it fit.
Bibliography
Drury, C. (2012). Management and cost accounting. London: Chapman & Hall.
Epstein, M. and Lee, J. (2011). Advances in management accounting. Bingley, UK: Emerald.
Gibson, C. (2008). Financial reporting and analysis. Cincinnati, Ohio: South-Western
Moles, P. (2011). Corporate finance. Hoboken, N.J.: Wiley.
APPENDICES
