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Time Value of Money & Net Present Value

by David Wyndham 11. February 2015 15:14
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Money is valuable. So is Time.

Back in 2011, I wrote about the time value of money in the aircraft acquisition process. A financial decision involves not only what the total costs are, but when the expenses and revenues occur. That article prepares you for the Net Present Value (NPV) discussion.

An NPV analysis takes into account the time value of money, as well as income and expense cash flows, type of depreciation, tax consequences, and residual value of the various options under consideration. When an expense (or revenue) occurs can be as important as the amount of that item. For example, taking into account an aircraft's resale value, a cash purchase will have lower total costs than the finance option or lease option (for a long term lease). The cash purchase is due up front. The principal and interest, or lease payments, are paid over time. 

The NPV calculation applies a time value of money rate to when income and expenses occur. This time value of money is referred to as internal rate of return (IRR) or return on investment (ROI). Many organizations have a published IRR or ROI target. For companies that don't, a way to estimate it is by dividing the profit before taxes of the organization by the equity and expressing as a percentage the return the organization expects to make on the money it invests in the enterprise. For many organizations, such as Fortune 500 companies, this is typically from 10% to 15%. The rate could be higher when accounting for financial risk. Government agencies can use the current rate of return for Treasury Bills or State Bonds. High Net Worth individuals may use their current returns they are getting from investments, or the interest rate when they borrow money.

Paying cash may not have the best NPV when the value of money is high. In general, if internal rates of return are greater than the financing terms, and allowing for the tax depreciation of the aircraft, the NPV favors the finance option over the lease for most of our corporate clients. Lease NPVs tend to be favored when there is little or no tax depreciation benefit, or the term is very short - under five years. 

By using the time-value of money, you can judge whether a project will yield a better or worse return than the average return experienced on a company-wide basis. Thus, the NPV analysis allows the comparison of different cash flows based on a set target return. It also allows comparisons of buy versus lease versus finance options of the same aircraft. This type of analysis is also the only effective way of judging the finances of a purchase, finance, or lease, especially if different conditions and interest rates apply to each alternative. It is the standard financial analysis technique used by the chief financial officers of major organizations.

An NPV of zero means that the target return has been met. A negative (less than zero) NPV means the target return has not been met. A positive (greater than zero) NPV means the target return has been exceeded. For something like a business aircraft acquisition, the only revenue generated is if there is some charter revenue  and when the aircraft is sold. Business aircraft, and privately flown aircraft, will have a negative NPV. In order to compare non-revenue NPV, the NPV closet to zero (or "least negative") is the most favored financial option.

Companies will compare at the NPV of very different projects.  The NPV comparison may include the purchase of an aircraft along as compared to the acquisition of land for a factory. $20 million buys a very nice business jet, or a lot of land. The finance terms and tax advantages of both can be very different. They company may decide to purchase the aircraft and use financing for the land. They may not finance either due to wanting to avoid too much long term debt on their balance sheet. Companies may avoid financing an aircraft simply to avoid having the aircraft debt on the balance sheet.

When I'm doing a financial analysis for a corporation, they may have me provide only the cash expenses. They then run their own internal NPV analysis so they can look at the corporate debt and taxes at a  higher level. Sometimes, the company will purchase the aircraft for cash without an NPV analysis as a matter of internal policy. Government agencies tend to have very clearly defined criteria for their capital acquisitions.

For any aircraft acquisition, the assumptions used need to be clearly spelled out. The costs should cover a specific period and take into account an expected aircraft value at the end of the term. Comparisons of two or more options should also cover the same period of time and utilization. This provides a fair (or "apples-to-apples") comparison. A complete Life Cycle Cost also accounts for the time-value of money in an NPV analysis. This way, the differing cash flows form two or more options that can be compared and analyzed from a fair and complete perspective.

The NPV may not be the final determinant in an acqusition, but it should be considered. The smart money says so.

 

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2015 Business Aviation Outlook - Sunny Skies?

by David Wyndham 7. January 2015 11:38
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2014 was an interesting year for the aviation economy. There were strong signs of improvement but still there was a feeling of wariness.  Globally, corporate profits were increasing in 2014 with estimates of 5% real GDP growth in the US. According to CNN Money, the number of billionaires doubled in the past six years. Both of those represent a growing set of buyers for turbine aircraft, especially business jets. New aircraft sales volume in 2014 looks to be about $21 billion. The US Dollar was up 11% this past year, a good sign for those Americans purchasing non-US goods (hurray for Dassault and Embraer?).  

Oil is now at $50 per barrel. Good news for turbine fuel prices, bad news for the oil & gas industry. I heard two Texans exclaim how strong the oil market was recently, but they were talking about Texas-produced olive oil! There are no signs of significant oil price increases, so that should help with the cost of flying in 2015.

Aviation International News reported a 10% increase in print advertising in 2014. Given the state of most print media, this is almost miraculous. Looking at AIN's December issue I counted 15 full-page ads - six from the aircraft manufacturers. That shows some hope on the part of their advertisers for as good year ahead.

New aircraft sales should continue to do well in 2015. Not because of bonus depreciation, but because of pent up demand. Business and high net worth individuals have the cash and look to be spending more of it. Lenders are also competing for quality - both assets and clients.

Used aircraft prices pretty much stabilized in 2014. We finally saw the recovery in the light jet market. Aircraft for sale data from AMSTAT shows the number of days to sell a light jet in 2014 was 326 days. Close to that for the large jets (312 days) and a bit worse than medium jets (283 days). The percentage of the business jet fleet for sales remains at just over 10%. Still, there is a bifurcated market for used business jets. Those built in the late 1990s and newer with updated avionic systems and engines on guaranteed hourly programs are selling well. Older business jets are still not faring as well. As an example, 18% of the active Citation II fleet is for sale as compared to 4% of the Citation CJ2+ fleet. A used business jet with ADS-B Out, RVSM, and engines on a guaranteed hourly program will sell first and for more than others who lack that equipment. 

The turboprop market seems unremarkable. Medium turboprops (AMSTAT lists King Air 200/350, PC-12, et al in this category) are at 6.6% of the active fleet for sale which indicates a sellers' market. But prices are not climbing. 

The helicopter market, especially for the larger turbine models, is beginning to feel the pain of lower oil prices. The demand for helicopters in the oil and gas markets is a major driver in that market. A client who owns a small helicopter charter company said that helicopters make money when everyone else is miserable:  high oil prices, forest fires, flooding, and accidents! It may take a year or more for the declining oil prices to significantly impact new helicopter orders. Still, there is a looming shortage of trained helicopter pilots and look for that to continue. 

With increased flying comes increased need for maintenance. MROs should do well this year. Avionics shops should be running at full capacity. Less than 5,000 of the 200,000 US registered aircraft have been equipped with ADS-B Out. The FAA says midnight on December 31, 2019 is still the deadline with no exceptions.  

I think 2015 will be a growth year for business aviation and aviation in general. Nations whose economies that are not dependent on oil revenues should do well for aircraft sales.  As always, managing costs and focusing on the customer will be important for all of us. Good luck to you in 2015. 

 

 

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Three Levels Of Budgets

by David Wyndham 1. December 2014 10:11
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As 2014 is in its last month, many of you are looking toward the holidays. One item for those in management positions may be standing in the way of a happy holiday - your budget for the flight department. Too many organizations look at budgeting as a pain filled process. It need not be that way.

Budgeting is a very important tool for planning an organization's use of its most limited resource - cash. Managing  cash is critical for any business or individual. The budget is supposed to be an estimate of the future financial state of your organization. Used correctly, the budget can be an asset in managing your aviation cash rather than a once-and-done exercise.

Within your aviation organization, you probably need three levels of budgeting. Think of them as tactical, operational, and strategic. A tactical budget is the lowest level of budgeting. It may be your training budget for the flight department. You build up the training budget from the tactical level of who goes to train, the cost of the course, and cost of travel to attend the course. It may even include the cost of a temporary pilot to fill in a busy flying schedule. 

The operational level of budgeting is the one as an aviation manager, you need to be the most concerned with on a day to day basis. It covers the main areas of functional responsibility that you have. 

For an aviation operation, maintenance is one of the largest expenses, and one in which the aviation organization can have the most control. However, in order to effectively manage those expenses, you need to know what is expected and be able to measure and track them during the year. Planning for your maintenance may take the most time in your budget preparation. Rather than a single budget item of maintenance, you should have more levels of detail so that you can better manage those maintenance costs. This may include categories like unscheduled, scheduled, parts, external labor, refurbishment, overhaul, etc. 

The budget that you submit to the CFO is used to meet the strategic level of budgeting. The senior leadership and Board of Directors need to know how well the company is meeting its strategic, long-term goals and objectives. The fact that your temp pilot costs $1,000 per day is not important to them. The fact that you are acquiring a $20 million business jet is. One organization that I've worked with has three line items in the flight department budget that is  submitted to the CFO: personnel, facilities, and equipment. 

As the flight department manager, you need to build up to the strategic level of the CFO from the level of the tactical.  Things like training, maintenance, etc can be done with the help of your team. Assign the Training Captain and an admin to research costs for training. Work with your Director of Maintenance to make sure you cover the all bases for upcoming maintenance in 2015. 

Make sure you have a good estimate on your planned-for flight hours in 2015.   Ask upper management about their intended aircraft usage for the next year, or ideally, several years. Will there be more or less flying, any new destinations, etc? If you are budgeting any optional maintenance items or upgrades, ask if next year or the year after works better for the financial goals of the company. 

Document Your Assumptions. Things will be different next June than they were the previous December.  The biggest changes may be in the variable costs as you fly more or fewer hours than estimated. How will changes in hours flown affect when major maintenance is due? When conditions change, these recorded assumptions will better guide you on revising the budget better than relying on your memory.

As an aviation manager, the budget should be more than just filling a square for your upper management reporting. It is a very useful tool that can enable you to track the effectiveness of your aviation operation. It can also alert you to the future peaks in expenses, such as scheduled major maintenance or an aircraft upgrade.  

Think of a budget as your fiscal flight plan. After take-off you check the winds, your fuel status, and the level of coffee in the urn. Monitor the fiscal flight plan the same way with the same goal: to arrive at your (year end) destination safely and comfortably. 

 

 

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David Wyndham

Metrics and Measurements for Business Aviation

by David Wyndham 6. November 2014 13:54
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A metric is nothing more than a measurement.  It is used to gauge or measure some sort of performance. Metrics for pilots can include flight hours flown, instrument approaches flown, cross-country or IMC hours, and landings. All of these metrics can be used to measure the level of proficiency of a pilot. If a pilot has not logged an instrument approach in the past 90-days,  how proficient would she be to fly an approach on a windy, rainy, foggy night?

In a business, metrics are used to measure the company's performance, typically connecting it to costs and profitability. Metrics like return on investment (ROI), employee turnover, the cost to acquire a new customer are a few.  For a pilot, hours flown can be connected to proficiency. Fly more hours and you should have a higher level of proficiency. For a business, generating more revenue per square foot of retail space is a sign of proficiency in profitability.

In business aviation, we tend to stick to the pilot-centric type of metrics. We report hours flown per month, average trip lengths, passenger loads and perhaps unoccupied legs (deadhead). But how do these measure the level of effectiveness for the business aircraft? If a business aircraft flew 35 hours in September and flew 45 hours in November, is it doing a better job or increasing its level of performance for the business? How does flying 10 more hours this past month justify the effectiveness of your business aircraft?

Metrics, by definition, must be measurable. But they must also be valid. A metric that is valid can be used as a predictor of performance. You could have flown 10 more hours last month in holding patterns due to ATC and weather delays. Or you could have flown 10 more hours helping the executive leadership earn a new client for the company. For a charter operator, were the 10 hours billable-hours or non-revenue positioning hours?

What metrics to have for the flight department depend entirely on the missions assigned to the flight department. For a corporate shuttle, passenger-miles flown could be an important metric.  That can mean that the aircraft is serving its corporate customers and saving them travel time. Hours flown per business unit might be a good indicator. If the sales team is flying more hours, might that be indicative of a future increase in sales? If legal and accounting are flying more hours, is that good (a major acquisition) or bad (trouble with Wall Street)?

Costs should factor into your metrics.  Are we getting value for the money? For a charter operator, cost per hour when compared to revenue per hour is vital.  But for the corporate shuttle, cost per hour might not be enough. What about cost per passenger mile? That is handy when looking at a 10-seat aircraft versus 15 seats.  A Gulfstream G150 costs less per hour than a G450, but if your travels take you transcontinental or longer, is cost per flight hour telling the story?

What does your company need to know to show that the business aircraft is being properly utilized? Are the priorities with the use of the aircraft aligned with the overall corporate priorities? Depending of the role of the business aircraft, many metrics will be different.

One metric I think every flight department should follow is Aircraft Availability. This metric is the amount of time an aircraft is available to be flown or is scheduled to be flown as compared to the total operating period. 

Hours aircraft available / Total hours of schedule

This metric is expressed as a percentage. The key is defining the operating period. For an emergency medical EMS helicopter, they need to be available   24 hours per day, seven days per week. For the senior executive transport, the business aircraft may be needed 12 hours per day, six days per week. Regardless of the schedule, if the measured aircraft availability rate is declining over time, that can indicate an increased maintenance load.  I have seen an operator who had such poor aircraft availability, in order to meet a two-aircraft per day flight schedule, they operated five aircraft. 

What is the role of your business aircraft as it relates to the goals and mission of the corporation? How best can you measure the effectiveness of your aircraft as it relates to the corporate goals? Seth Godin said that when you step on the scale, you'd better be prepared to do something about it. So in choosing metrics for your flight department, choose ones that tell the story and that you can use to show how well you are serving the company.

What do you see as an important metric for your operation and whay? Tell us in the comments.

 

 

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David Wyndham

2014 Business Jet Traveler Survey says...

by David Wyndham 3. October 2014 11:09
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Business Jet Traveler magazine's fourth annual Reader's Choice survey is in their recent issue. They had over 1,200 readers respond, a new record for them. The big take-away from the survey is that things should continue to improve for business aviation. While about half stated their flying would remain at current levels, almost 40% stated they would fly a bit more or much more in the next year. Less than 10% said they would fly less in 2015.

The survey is to be posted online at bjtonline.com/2014survey. if you don't have access to the magazine. Here are my observations of that survey.

Why people fly privately doesn't really change. It saves time and general aviation serves many more airports than the airlines. The most important features people are looking for are range, economics, and cabin.  I see that in my consulting. What was interesting in that group was that cabin amenities, product support and baggage were at the bottom of the important features list. I think it is because product support is generally good and everyone expects the cabin amenities to be about the same within categories. Baggage is likely a tertiary item, especially since seats are rarely filled on many trips. Safety is important with over half stating they only fly with operators that have passed a safety audit (I think it should be 100%).

Of the non-owned methods of flying, fractional, jet cards, and charter, all three rated very good to excellent in customer service and cleanliness of aircraft.  Concerning choices of aircraft and age of aircraft, fractional and jet cards rated better than did charter. I was surprised at the charter choice of aircraft rating below the others. 

When it came to value for the price paid, fractional and charter rated better than jet cards. I think jet cards took a hit there as they also took a lower rating for transparency/explanation of charges.

For the owned aircraft category, BJT separated fixed-wing and helicopters. Since people valued range, economics, and cabin, I looked at those related ratings from the owned group. 

For the fixed wing: With respect to cost of maintenance, Embraer came out with the best ratings at 75.1% rating them excellent or very good. None of the other aircraft manufacturers listed had greater than 60% excellent or very good. Gulfstream rated over 99% excellent or very good for reliability. Everyone rated over 90% for reliability. Regarding cabin amenities, both Dassault and Gulfstream rated the best of the group. As both concentrate mostly on the large cabin jets, it makes sense that owners would be please with the offerings of the large cabin aircraft. Overall satisfaction was very good for everyone, but Dassault, Embraer and Gulfstream did rate a bit higher then the others. 

It looks like there were not a lot of responses from helicopter operators as only Airbus Helicopters (nee Eurocopter) and Bell were represented. Other than reliability, the helicopter manufacturers did not get as favorable ratings as did the fixed-wing. Cost of maintenance was a big knock against the helicopters with no one rating Airbus as excellent and Bell getting only 17.1% excellent ratings for their maintenance costs. I wonder if it is due to generally more complex maintenance requirements of a helicopter versus an airplane, especially with respect to time and cycle-limits on a helicopter's many components. 

BJT did ask its reader's that if they could get a year of complimentary flying, which aircraft would it be for various categories of aircraft? Read the article to see what folks favored. For me, they didn't list a P51 Mustang nor an amphibious Twin Otter so my top choices were not there. 

I'm hopeful that the BJT reader's interest in flying more in 2015 is representative of business flying in general. We shall see.

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