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Analysis and Audit Plan:

Southwest Airlines
ANNUAL REPORT INFORMATION
COMPANY INDUSTRY
Southwest Airlines Co. is the nations low-fare, high Customer Satisfaction domestic airline (2005
Financial Statements). Southwest is part of the airline industry, which is in the business of transporting
paying passengers and freight by air along regularly scheduled routes.
According to Investopedia.Com, If the airline industry could be described in three words, it
would be considered an intensely competitive market. In recent years, there has been an airline
industry-wide shakedown toward expanding domestic and international services. Originally, the
airline industry was either partly or wholly government owned. This is still true in many
countries, but in the United States all major airlines are private. The airline industry is classified
into four categories by the Department of Transportation (DOT):
1) International - 130+ seat planes that have the ability to take passengers just about
anywhere in the world. Companies in this category typically have annual revenue of $1
Billion or more.
2) National - usually these airlines seat 100-150 people and have revenues between $100
million and $1 billion.
3) Regional - companies with revenues less than $100 million that focus on short-haul
flights.
4) Cargo - these are airlines whose main purpose is to transport goods.
The Southwest began services in June 18, 1971, but became a major participant in the airline industry in
1989 when it exceeded the billion-dollar revenue mark. Southwest is one of the largest carriers based on
scheduled domestic departures. In the United States, Southwest is considered one of the most successful
low-fare, high frequency, point-to-point carriers (www.southwest.com).
PRIMARY PRODUCTS/SERVICES
Southwest Airlines primarily serves short-haul and medium-haul city pairs, providing
single-class air transportation, which targets business and leisure travelers (2005 Annual
Report). Although primary function of Southwest is to fly planes, Southwest Airlines
considers itself a more of a Customer Service Company. Southwest is a unique airline participant because it
differentiates itself from their competitors with their employees offering customer service. Employees of
Southwest Airlines are motivated to increase productivity in order to enhance their product without adding
to the cost structure. Southwest Airlines is committed to providing customer satisfaction through offering
free amenities during flights such as name-brand snacks, nonalcoholic beverages, blankets and pillows on
every flight. Their competitors are cutting down on these amenities, while Southwest is continually
providing them to ensure a satisfying and comfortable flight experience. Southwest Airlines cabins are also
comfortable and clean and feature attractive leather seats (2005 Annual Report).
In addition to providing comfortable air transportation, Southwest Airlines also reaches
out to individuals, families, and entire communities, by providing help where it is needed. Since

Hurricane Katrina, Southwest has contributed millions of dollars in services and cash to the New
Orleans Relief Funds. Also, they have partnered with numerous organizations to provide travel,
raise funds, and bring awareness to the needs of the New Orleans community. Southwest also
generously supports the Ronald McDonald House, and offers the Adopt-A-Pilot mentor program.
Southwest and their employees offer their assistance to their communities in every way possible.
RAW MATERIALS
The most notable raw material for Southwest Airlines is fuel that is used by their airplanes. Jet fuel price
per gallon have increased 43 percent over the last couple years, yet Southwest Airlines still manages to
show strong revenue growth due to their excellent cost controls. Southwest reported its 33rd year of
consecutive profitabilitya record unmatched in aviation history. They were able to accomplish this with
their protective fuel hedging program. Hedging fuel prices has allowed Southwest to pay $26 per barrel,
while the market price averaged around $70.
SIZE OF THE COMPANY
Southwest is the largest airline in the United States by number of passengers carried
domestically for any one year and the third largest airline in the world by number of passengers
carried. Its size can be measured by three factors: Sales / Revenues, Assets, and employees.

Sales / Revenues
At the end of 12/31/05, the net sales or revenues for Southwest Airlines were $7,584 Million.

Assets
Total Assets for Southwest Airlines at the end of 12/31/05 were $14,215 million. A
breakdown of the assets is as follows:

Assets
Cash & ST Investments
Cash
Short Term Investments
Receivables (Net)
Inventories - Total
Raw Materials
Other Current Assets
Current Assets - Total

2,531.00
2,280.00
251
258
150
150
681
3,620.00

Property Plant & Equipment - Net


9,427.00
Property Plant & Equipment - Gross
12,915.00
Machinery & Equipment
12,091.00
PP&E - Other
660
PP&E Under Capitalized Leases
164
(Less) Accumulated Depreciation
3,488.00
Other Assets
1,171.00
Tangible Other Assets
1,151.00
Intangible Other Assets
20
Total Assets
14,218.00
Employees
According to Southwest.Com, there are more than 32,000 total employees throughout the
Southwest system. Employees are greatly valued by Southwest Airlines. Southwest has
learned that treating employees well goes a long way to achieving higher efficiency and
customer satisfaction.
COMPANY LOCATION
Southwest Airlines incorporated in Texas, commenced Customer Service on June 18,
1971, with three Boeing 737 aircraft serving three Texas citiesDallas, Houston, and
San Antonio. Currently, Southwest Airlines headquarters is in Dallas, Texas. Southwest Airlines currently
flies to 63 cities in 32 states. As of January 31, 2007, Southwest Airlines top ten Airports are:
Daily
Cities
Departures
Las Vegas
225
Chicago Midway
218
Phoenix
207
Baltimore/Washington
173
Oakland
142
Houston Hobby
141
Dallas (Love Field)
127
Los Angeles (LAX)
118
Orlando
100
San Diego
92
ASSOCIATED COMPANIES/PEOPLE

Number
of Gates
21
29
24
26
11
17
14
11
12
10

Nonstop Cities
Served
53
47
42
38
20
28
14
19
32
15

Established
1982
1985
1982
1993
1989
1971
1971
1982
1996
1982

Employees, the airline personnel, investors, creditors, executives, leasing companies and others are closely
associated with Southwest Airlines. Employees, including all the airline personnel such as the pilots, flight
attendants, ticket agents, travel agents, baggage handlers, security, avionics technicians and many others are
the individuals most closely associated with Southwest Airlines. Employees of the airline companies
depend on the company to be profitable, because when a company is profitable and not in threat of
bankruptcy, they have job security within the company. Too many people have lost their jobs, when
companies failed and went bankrupt.
Southwest Airlines has contractual obligations and commitments primarily with regard to future purchases
of aircraft, payment of debt and lease arrangements (2005 Annual Report). Boeing is the main
manufacturer of the aircrafts used by Southwest Airlines and is very closely associated with the company.
As of December 31, 2005, Southwest had contractual purchase commitments with Boeing for 33 deliveries
in 2006 (2005 Annual Report).

All the lenders and creditors who extend credit to Southwest are parties who are closely associated with
Southwest Airlines. These lenders and creditors rely on Southwest Airlines to continue being profitable
because their profitability will determine the ability of that company to meet current payments of a debt.
Investors and stockholders are also closely interested in the company since they invested their money into
this company expecting to make a profit.
A LOOK AT THE ANNUAL REPORT
The annual report is broken down into numerous segments and provides multiple functions. The report
starts off with the consolidated highlights, this section describes through charts and graphs how the
company fair during the course of the year. It provides comparisons to past years, and serves as a brief
overview about the companys earnings. The next section is a letter to the shareholders from the president,
chief executive officer, and the chairman of the board. This section provides both an explanation of what
happened to the company during the year and reassurance to the investors from these individuals. The
annual report also describes the airline market and how that is affecting Southwest Airlines. The rest of the
report discusses the companys financial information through a series of pictures, charts, graphs, and
comparisons. The annual report is a polished report that is available to help reassure Southwests investors
that it is a successful company and that it will continue to fair well in the future.
Financial Statements tend to biased in representing the true standing of a company. There is a high level of
concern regarding financial statements expressed by individual and institutional investors, mutual funds,
pension funds, creditors, financial analysts and other users of financial statements. Financial Statements
are widely used by investors to make their investing decisions. Companies knowing that their financial
statements are used by investors, tend to make their statements look appealing to the general public.

Southwest Airlines 2005 and previous year annual reports show the company as a very profitable, strong
and constantly growing company. The revenues and net income are increasing from year to year.
Southwest emphasizes that they experienced 33 years of profitability, while other airline companies filed
bankruptcies. In its annual report, Southwest also focuses on informing the shareholders of the great cost
control methods that they implemented which have allowed them to be the best in providing low-cost deals.
This annual report tries to appeal to a large number of people by proving to them that Southwest indeed is
the number one low cost provider of air transportation services. Southwest Airlines is able to accomplish
this reputation through cost efficiency and customer satisfaction.

THE 10-K INFORMATION


ANNUAL REPORT VS. 10-K
The annual report is the official document that companies create and distribute to their shareholders
annually. The annual report includes the financial statement for the year, as well as, highlights and a
reflection from the management about the previous year. Many times, companies also include graphs and
photos to add more of a professional element to their report. Compared to a 10-K, normally an annual
report is much more concise document, that investors use as a tool to get an overview of the company.
The 10-K report is the official annual financial document that companies file with the SEC. The 10-K is a
document that contains details about the companys financial statements, as well as, financial footnotes to
give a more descriptive overview of the company. The 10-K lacks the visually pleasing photographs, charts
and graphics, which are usually included in the annual report to give the consumers and investors a
polished briefing of the company. The 10-K supplies more in depth details about the company for
individuals who are looking to research the company. The document is filed electronically in a text format,
so it is easy to search through.1
COMPANY INDUSTRY
Southwest Airlines Co. is a major passenger airline company that provides air transportation only in the
United States. Currently, Southwest Airlines is the largest carrier in the US. By the end of 2006,
Southwest, operated 481 Boeing 737 aircraft and provided service to 63 cities in 32 states throughout the
United States. Southwest primarily focuses on direct flights, using point-to-point flights, rather than huband-spoke, service. It is an airline company that uses low pricing and easy flying as its strategic advantage.
As stated in the companys 10-K, Southwests primary selling point is low prices. They can keep flying
inexpensive because they try to minimize their operating costs, Southwest has the lowest costs, adjusted
for stage length, on a seat mile basis, of all the major airlines. Among the factors that contribute to its low
cost structure are a single aircraft type, an efficient, high-utilization, point-to-point route structure, and

www.library.cornell.edu/johnson/library/faq/annreport.html

hardworking, innovative, and highly productive employees. Other airline companies try to keep pricing
low as well, but Southwest competes through quality, frequency, and locations of flights.
PRIMARY PRODUCTS/SERVICES
Southwest Airlines provides a service for its customers. This company provides air transportation for
individuals all over the nation at competitively low prices. The airline industry is an incredibly competitive
one. According to Southwest Airlines 10-K Report, they have isolated a few principal competitive factors
that they feel are vital to the industry. One of the first principals listed is fares. The main reason
individuals fly through Southwest is because they offer highly competitive fares. They do this by looking
at the industrial and personnel costs, and attempt to maximize their output, while at the same minimizing
their input. Even though they attempt to keeps costs low, they have a few priorities that they cant avoid.
One of the obstacles that Southwest had to deal with is the constant rise of gasoline prices over the last few
years. Another obstacle Southwest deals with is reassuring its customers that even with highly competitive
pricing, that they do not sacrifice its high level of customer service. Southwest has worked hard to improve
its services by improving its frequency and convenience of scheduling. Another priority is retention of
customers; in order to do so Southwest also constantly attempts to improve its frequent flyer benefits. Just
as any other business, another main principle is to improve efficiency and productivity. All of these
elements are essential in operating a successful business.
RAW MATERIALS
One of the biggest raw materials that airline companies must use is fuel. Due to the rising gas prices over
the years, it has made it incredibly difficult for airline companies to keep air transportation prices the same.
According to Southwest Airlines 10-K, Operating expenses per ASM increased 9.3 percent to 8.80 cents,
primarily due to an increase in jet fuel prices, net of gains from the companys fuel hedging program. The
companys average cost per gallon of fuel increased 48.5 percent versus the prior year. Excluding fuel,
year-over-year CASM was realistically flat in 2005. Based on current cost trends, the company expects
first quarter 2007 unit costs, excluding fuel, to increase from 2006s full year figure of 6.49 cents.The
average cost per gallon of jet fuel in 2006 was $1.53 compared to $1.03 in 2005, excluding fuel-related
taxes and net of hedging gains (SOURCE). The airline industry needs gasoline to run their respected
business. Fuel is the major raw material used by the airline industry. The company also requires strong
personnel and high quality airline equipment.
SIZE

COMPANY
Sales

OF THE

Assets

*Taken from Southwest Airlines 2006 10-K

Employees
According to Southwest Airlines 2006 10-K report, At December 31, 2006, Southwest had
32,664 active Employees, consisting of 12,954 flight, 2,056 maintenance, 13,446 ground,
Customer, and fleet service and 4,208 management, accounting, marketing, and clerical
personnel.

LOCATION
Southwest is based in the Dallas, Texas. According to the 10-K Report the company originated in Texas,
Southwest was incorporated in Texas in 1967 and commenced Customer Service on June 18, 1971, with
three Boeing 737 aircraft serving three Texas cities Dallas, Houston, and San Antonio.