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Performing a Financial Analysis: Part 2

by David Wyndham 1. December 2006 00:00
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In last month's we identified the basic financial data needed for the analysis. Remember, the goal of the financial analysis is to identify the aircraft that does the best job for the money.

In a financial analysis you will need to analyze all of the costs associated with the aircraft: acquisition cost, operating costs, depreciation and taxes, and the potential residual value after a set term. If the aircraft is to be used in a commercial operation, you will need to make assumptions regarding potential revenues as well. All of these considerations are important and needed to complete the analysis. Use the same set of assumptions for each aircraft to ensure that you get a true comparison.

Given a set of costs and assumptions, what next? You will need an analysis tool to perform a life cycle cost. A life cycle cost

- Takes into account the total costs and can show the impact of taxes and depreciation.

- Generates a cash flow analysis to show the years of negative cash flow - something a commercial operator wants to avoid.

- Examines the time-value of money for each aircraft and acquisition option.

The time-value of money places importance on the timing of a revenue or expense occurs. Think of interest. If I invest $1,000 at 5% per year, I'll have $1,050 at the end of a year. Similarly, if I owe you a $1,000, and I pay you today, I need $1,000. But, if I can wait a year to pay you, I can invest $953 at 5% and end up with $1,000 after a year. Taking the time-value of money into account allows you to compare different streams of revenues and expenses to see which one has the better time-value.

Terms used to describe the time-value "interest rate" include return on investment (commercial operations) and net present value (non-revenue operations like a corporate flight department of government). These are usually abbreviated as ROI and NPV respectively. For a revenue operation, the higher ROI is preferred. For a non-revenue operation, the "least negative" NPV is preferred.

What is a typical percent to use for the ROI/NPV analysis? You usually don't have to make one up. Government agencies usually look at the cost of borrowing money - Treasury Bill interest rates for example. Corporations have expected returns and use that for all major purchases. If you are in a large organization, just call the financial department, the CFO, comptroller, etc. and ask them for the relevant rate and your organization's marginal take rate. They will be impressed at your level of understanding!
Taxes and depreciation can play a role in the time-value analysis. If used 100% for business, the IRS allows 100% of the aircraft's value to be deducted, or depreciated, in as little as five years.

The final value, the aircraft residual value, is tough to estimate. Essentially it requires guessing at the future value of the aircraft. Looking at historical residual values of pre-existing aircraft can give you some idea of what the future may hold. We've looked at aircraft values for a number of years and, averaging good and poor economic times, will use a reduction in a jet aircraft's value of 3% per year, 4% for a turboprop or piston, and 5% for a helicopter. Right now, it is too much, but over time it is a reasonable estimate.

Now that you have your costs, ROI/NPV rate, and marginal tax rate, how do you perform the analysis? Prior to spreadsheets, it was a time-consuming process. Today, there are spreadsheet applications that, given the proper data entry, will quickly calculate cash flows and ROI/NPV. Just make sure what you use allows you the flexibility to compare the different options. Look for the ability to vary your cost assumptions and to create reports. If you are a pro at Microsoft Excel or other spreadsheet applications, you can even try to do one from scratch.

For a non-commercial operation, the only revenue will be the sale of the aircraft. This will never pay back the initial acquisition cost and all expenses, so the NPV will always be less than zero. In this situation, the "least negative" or value closest to zero is the most favorable NPV.

For a commercial operation, the goal is to recoup your initial investment, pay all your expenses, and generate a return (profit) equal to your stated ROI. Do this and the NPV is zero. If the NPV is less than zero, you have not reached your ROI goal, and if the NPV is greater than zero, you have exceeded your ROI goal.

What the financial analysis will allow you to do is to rank order the mission capable aircraft to find the one that does the best job for the money. Once you have done this, you can easily go back and adjust the assumptions and re-run the analysis for changes in acquisition cost, interest rates and other variables. This will give you a very clear picture of what your options are.

A financial analysis of the aircraft capable of performing your mission is the fairest way to identify the best value for your operation. It takes into account all the cost factors.

As always we welcome your input and experiences please post your questions or replies below.

Purchasing a Corporate Aircraft: Part 1

by David Wyndham 1. December 2006 00:00
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It seems that in aviation, there are two large groups, those who think finances are scary (read as job threatening) and those who think finances are just simply boring. Both groups try their best to avoid the subject. There is a third, a small but growing group that I want you to join -- those whose knowledge of finances gives them a powerful and convincing tool for making the right aircraft decision!

Before the financial analysis, you need to identify the aircraft capable of performing your mission. This analysis needs to cover performance, cabin/baggage/comfort, and support. Once you have a group of capable aircraft identified, the next step if the financial analysis.

For any aircraft financial analysis you will need the investment required, the cost of operation, and the estimated residual value of the aircraft at the end of the term. Taxes and revenue potential can also play an important part in the analysis. The objective of a financial analysis is to determine which of the qualified aircraft provides the optimum combination of these elements.

In aircraft financial analyses, we also need:

- Amount of utilization. Do this in miles and then divide by the aircrafts' typical trip speeds to arrive at the utilization in hours.

- Type of ownership. Full ownership, co-ownership, fractional ownership. Maybe not even owning at all. Differentiating among these is a subject for another newsletter. For this month, let's assume a form of full ownership.

- New versus used. Do the lower maintenance costs, increased availability, added tax depreciation benefits, and the ability to specify the exact configuration of the new aircraft outweigh the used aircraft's lower acquisition cost?

- Lease or Purchase? A lease typically has a very low initial payment, and depending on the type of lease, may not be considered "long term debt" on the corporation's balance sheet. Purchase includes both finance and full payment up front. With a purchase, you do have ownership and after the payment(s), have an asset with a definite value.

- Trade-in Value Assumption. If you currently own an aircraft, you need to get an idea of its current worth in the market. Price guides such as the Aircraft Bluebook Price Digest, Vref , and The Official Helicopter Bluebook offer a good starting point for determining the value of an aircraft. Nothing beats an appraisal by a qualified appraiser. An appraiser will give you the real-world value in today's market that will aid you in negotiations with buyers.

- Acquisition Price. For used aircraft, see the references above. You can also look at aircraft-for-sale web sites to see what the "asking" prices are. Keep in mind that there can be a considerable margin between asking and final selling price. An appraiser can also give you some information on used aircraft prices as well. For new, start with the manufacturer's list price. In today's market, most manufacturers are willing to make a deal, so don't count out a new model that is "just a little bit" outside of the target acquisition price.

- Length of ownership. When you analyze each aircraft, use an equal length of ownership. Looking at cash flows and costs over different lengths of time can give you a distorted picture. This is very important when considering the time value of money. When income or expenses occur can be as important as how much.

- The aircraft operating costs. This includes the fuel and maintenance. Also needed are things such as hangar, insurance, training, and crew salaries. Don't forget the miscellaneous things like charts and pubs, too.

Taking all the above into account over a defined period provides you with a Life Cycle Cost. This is step one. Step two will be to use the concept of the time value of money to differentiate between the cash flows. We all can agree that being paid today and paying our bills next week is the preferred way to manage our finances. This is the simple version of the time value of money. Next month, we will explain it in detail and complete the financial analysis.

If you have any ideas, suggestions or experiences you would like to share with this discussion we would like to hear about them.  Please respond below.

The Corporate Aircraft Pre-Buy Inspection

by Jeremy Cox 1. December 2006 00:00
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Thirty years ago it was unusual for a pre-buy inspection to be accomplished as a part of the aircraft acquisition process. As aircraft get older and as corporations have bought and sold more aircraft, a pre-buy inspection is now the norm, and rightfully so! Since there is a very high degree of financial risk associated with the purchase of an aircraft, it is vital that you select the most effective inspection regime for the dollar amount that you are willing to spend.

Advice is available to you on this subject from a variety of sources: your aircraft broker, the chosen inspection facility, operators of the same aircraft, the OEM, and owner groups, to name just a few. All suitable inspection facilities have an ‘in-house' checklist that they use to provide you with a pre-buy quote and to use while conducting the pre-buy or technical survey. Some checklists are excellent and some are downright pathetic.

It is imperative that know and understand what all of the critical and most important checklist items are for the model of aircraft that you are attempting to buy before you finalize the checklist that is to be used. To start with, the terms Airworthy and Flightworthy are extremely subjective and may be interpreted differently by all. To eliminate any possible conflict later, the pre-buy checklist that you select should include all of the items required by a standard phase or periodic inspection. This ensures that the inspectors at your chosen facility can apply a known standard to their determinations and rulings of Airworthiness.

If this is not possible, then at least demand that the facility compare their checklist to the maintenance schedule for the aircraft to ascertain what scheduled inspection and maintenance items can be cleared and signed off as complied with at after the pre-buy and closing. In many cases it is will only be necessary for you kick in an additional $500 or $1,000 dollars to pay for Lubrication Items only, to get a normal scheduled inspection signed off. Remember, it is normal for a seller to NOT allow any upgrades, modifications or changes to be made to the aircraft until after the transaction is closed.

However, if you are able to orchestrate having an inspection signed off prior to the closing, the seller will be more willing to allow this to occur, than the re-painting of the aircraft or any other more significant change items. Don't be surprised if the seller say's a very definite NO when you request that a C Inspection (due every 72 Months on a Falcon) be signed off as a part of the pre-buy, especially if the aircraft is not actually due for this inspection for another 24 Months or so. The sellers reasoning is that if you don't accept the aircraft and close, you have now put their normal budgeted maintenance schedule out of sequence.

The absolute best way to minimize your risk and exposure during a pre-buy is to hire a professional aircraft broker at the very beginning of the acquisition process. Thus before any aircraft is taken to pre-buy, your broker would have exhaustively searched the market for the specific model that you desire, selected three of the most suitable candidates, compared them and then your broker would have physically gone out to view both the candidate aircraft and their records prior to you making any offers on any aircraft. This ensures that you are buying an aircraft for the very best possible value and that you will have the least problems with it during and after the pre-buy inspection.

It should be the standard modus operandi of the broker that you have selected to represent you, to stay with all aircraft all-through-out the pre-buy inspection process, regardless of whether you are the buyer or the seller. This approach to the acquisition of an aircraft ensures that your interests are always held foremost during this potentially disastrous and expensive process.

We have all been through a Pre-Buy Inspection that has gone down the tubes (myself included, though I won't admit it) and those who read the discussion board want to know more before it happens again.  Reply to this discussioin and let others know about your experiences.  Good or Bad!

The Piston Aircraft Pre-Buy Inspection

by Jeremy Cox 1. December 2006 00:00
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The aircraft pre-purchase inspection is perhaps the most important aspect of buying an aircraft.  An aircraft pre-purchase inspection done well can save you thousands of dollars, done poorly and it could cost you your life!

It is pretty common for most prospective buyers of small, light aircraft, i.e. 'below 12,500 lbs, or 5,700 Kgs' commonly known as 'Puddle Jumpers' to handle the entire sales/purchase transaction themselves without any assistance from a professional broker. Of course there is nothing inherently wrong with this approach; it's just like you buying or selling your own home without using the services of a real-estate agent. I don't recommend this approach, but it is of course your prerogative to do so.

As you have decided to go it alone, here follows some points to remember.

Always ask to see a complete and consecutive set of log books that commence from the date of new delivery of the aircraft, up to the present day. If the candidate aircraft has many thousands of hours on it, then you should be faced with a substantial number of books. If you don't have all of the books, then it will be impossible for the owner to certify to you that the aircraft has 'no-known-damage-history.' This is a very important issue when you are trying to determine the market value of the candidate aircraft.

It is also normally a wise decision to select a pre-buy inspection facility or mechanic that does not normally have a relationship with the current owner. This is unless of course that the aircraft is not 'new' and still under the factory warranty.

Have the facility or mechanic perform the pre-buy inspection in accordance with a written checklist. If the chosen facility or mechanic is a specialist in this specific type of aircraft, it will be likely that they/he will have their own checklist to follow, which is normally over-and-above a normal aircraft inspection. In the situation where there is no specific pre-buy checklist available to your chosen facility or mechanic, and you have checked with the owner group or club that follows this specific aircraft type, then I strongly urge you to include all of the items normally required by the Annual and 100 hour inspection specified by the manufacturer of the aircraft. If the aircraft is an antique or a homebuilt machine, then I suggest that you use appendix D of cfr 14, FAR 91, subpart 43 as your guide.

Do a test flight first and make sure that your mechanic is along for the test. Have a specific flight profile that you wish to follow, to enable accurate trends to be captured for analysis post flight. Also make sure that the autopilot and all of the applicable avionics work correctly and accurately.

If at all possible, have the aircraft pressurized with a 'huff' cart on the ground, to check for leaks, if the aircraft is a pressurized type. Don't just rely on the test flight to verify that the system is working correctly.

Don't just rely on the results of a differential compression check of each cylinder, have each 'jug' and the rest of the engine borescoped too.

Invest in a Spectral Oil Analysis Program (SOAP) kit for both the engine oil and airframe hydraulic systems. Hopefully the candidate aircraft's owner has been maintaining the aircraft under such a program for as long as he has owned the aircraft, and then in this case you will only have to verify with the laboratory that the program is current and up-to-date.

Have several of the special inspections specified by the manufacturer of the aircraft, accomplished as a part of the pre-buy inspection. These might include a Symmetry Check, Lightning and Gauss Checks, a Heavy Landing Check, a Fabric Hardness/Condition Check (in the case of fabric covered aircraft), an Ultrasonic or 'Coin-Tap' Test (in the case of composite aircraft) and possibly a Rigging Check (especially if the aircraft is a wire-braced Bi-Plane.)

It goes without saying that a complete and comprehensive verification of the Airworthiness Directives, Service Bulletins, Service Letters, Supplemental Type Certificate changes and Major Component Total Time in Service and Serial Number confirmation is an absolute must-do as a part of your pre-buy inspection.

As soon as all of the above items and possibly a great deal more have been performed for you to complete your pre-buy inspection, make sure that both you and the seller receive a written report of all of the findings as a direct result of the pre-buy inspection. Hopefully you have already written into the purchase agreement that has been agreed too, and signed by both you and the seller that the aircraft will be delivered to you in an 'Airworthy Condition.' If this is so, then you now have a shopping list of items that may well be the responsibility of the seller to either fix, or discount off the purchase price before you can close the transaction. Remember that the cosmetic condition of the aircraft is generally irrelevant to the airworthy condition of the aircraft, unless a specified standard has been agreed to in the purchase agreement.

If you have a damage and corrosion free aircraft that is airworthy, then you probably have a keeper.

As always you can reply to this discussion with questions and experiences, let others know about how you have handled your pre-purchase and any ideas as they apply to the 'Puddle Jumper' Pre-Purchase Inspection.

Choice of Entity for Aircraft Ownership

by Greg Reigel 1. December 2006 00:00
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You have probably read the ads in several of the aviation magazines suggesting that aircraft buyers should "incorporate in Delaware" etc. Also, quite often an aircraft buyer's accountant or attorney will recommend that he or she form a corporation or limited liability company ("LLC") to own the aircraft. But does this make sense? In most cases it does. Let's talk generally about two of the most common types of entities, a few of the benefits of using those entities to purchase an aircraft and the regulatory concerns that may be encountered.

Types Of Legal Entities

A variety of legal entities are available for ownership of an aircraft: partnership, limited liability partnership, corporation, LLC etc. Two of the most common are the corporation and the LLC. A corporation is owned by all of its shareholders, who own the stock of the corporation. A shareholder's stock certificate(s) is evidence of the shareholder's ownership in the corporation. The corporation has a Board of Directors that elects officers to handle the day-to-day business of the corporation.

An LLC is organized similarly. However, members, rather than shareholders, own an LLC. LLC members do not own stock in the LLC, but simply hold a membership interest in the company that is represented by the members' capital accounts. Similar to the corporation, the LLC's members elect a Board of Governors that elects managers to handle the day-to-day business of the LLC.

A corporation and an LLC are each treated as a separate "person" in the eyes of the law with an independent existence from their respective owners. Thus, if the owner of a corporation or LLC dies, the entity continues to exist (although an LLC needs to specifically elect to have this continuity of existence). Additionally, the laws governing both types of entities require that certain formalities be observed (e.g. annual meetings, separate checking accounts, maintaining corporate/company books and records etc.).

Reasons For Using An Entity

Limited Personal Liability. One of the primary benefits of a corporation or LLC is the limited personal liability protection the entity affords. An owner of a corporation or LLC, simply by virtue of that ownership interest, is not personally responsible for the debts and obligations of the entity, other than to the extent of his or her ownership interest in the corporation or LLC. This is in contrast to a sole proprietorship or partnership in which the individual's mere ownership interest does result in the owner being legally responsible for the debts and obligations of the business.

Similarly, a director/governor or officer/manager is not personally responsible for the debts or obligations of the corporation or LLC as long as the individual was acting within the scope of his or her duties on behalf of the corporation or LLC. For example, if an individual leases a hangar on behalf of a corporation or LLC and then the corporation or LLC defaults under the lease, the landlord cannot hold the individual who signed the lease responsible for the default, unless the individual was not authorized to enter into the lease on behalf of the corporation or LLC or the individual otherwise personally guaranteed or obligated him or herself under the lease.

However, in the context of aircraft ownership, this limited liability protection is not absolute. If an individual, who may be a shareholder/director/officer of the corporation or member/governor/manager of the LLC, is operating an aircraft owned by the corporation or LLC and that individual is involved in an accident or incident that results in damage to property or personal injury, that individual could still be held personally responsible for his or her negligence etc., in addition to the corporation or LLC. Also, if an individual acts outside of the scope of his or her authority to act on behalf of the corporation or LLC, he or she may be held responsible for any consequences of those actions.

Confidentiality. Typically, a corporation or LLC can be formed and filed with the governing state without disclosing the names of any of the parties involved other than the incorporator or organizer for the entity. However, this confidentiality does not apply equally to the registration of an aircraft with the FAA. A corporation may register an aircraft in its corporate name with a corporate officer executing the application for registration. However, although an LLC may also register the aircraft in the name of the LLC, an LLC statement disclosing the names, addresses and citizenship of the individual members will need to be executed and filed with the FAA to confirm that U.S. citizenship requirements are met.

Tax Reasons. A corporation's or LLC's ownership of an aircraft may provide tax benefits that may not otherwise be available to an individual or partnership (depreciation, deductions etc.). However, each situation is different and must be analyzed by a tax professional to determine the availability of such tax benefits.

Regulatory Concerns

Although an aircraft buyer may be able to benefit by using a corporation or an LLC for his or her ownership of an aircraft, the aircraft buyer also needs to be aware of the regulatory issues that may result from this ownership structure. One of the primary regulatory concerns may arise when an aircraft is purchased by, and operated from, what is commonly referred to as a "flight-department company". In this scenario, the buyer, which may be an individual or a business, purchases an aircraft. Intending to limit personal liability, the buyer forms a separate corporation or LLC to own the aircraft. The corporation or LLC then operates the aircraft for the buyer under FAR Part 91.

Unfortunately, if this arrangement isn't structured properly, the FAA could view the corporation's or LLC's operation of the aircraft on behalf of the buyer as a commercial operation requiring an air carrier certificate. Accordingly, any operation of the aircraft by the corporation or LLC on behalf of the buyer without an air carrier certificate could subject the pilot(s) actually flying the aircraft to an FAA enforcement action and subject the corporation or LLC that owns and operates the aircraft to a civil penalty action.

Similarly, depending upon how this arrangement is structured, the Internal Revenue Service could view the corporation's or LLC's operation of the aircraft as a commercial operation requiring the collection and payment of Federal Excise Tax on any flights performed on behalf of the buyer. Alternatively, a private operation may only require the collection of sales tax.

Conclusion

Using a corporation or LLC to own an aircraft can provide benefits to the aircraft buyer. However, each situation is unique and must be analyzed to confirm that the aircraft buyer will actually receive the benefits expected and that the ownership arrangement will comply with the regulatory requirements anticipated by the aircraft buyer for operations under FAR Part 91. As they say, "the devil is in the details." Aircraft buyers desiring to use a corporation or LLC for purchase of an aircraft should work with a knowledgeable aviation attorney to ensure that the transaction is structured appropriately to meet the regulatory requirements applicable to their particular situation.

Question:

What way have you used?  Pros... Cons.  Let us know!



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